Access to Credit: Auto Loans and Mobility

As our contribution to the ongoing discussion America is having around racial inequality, here is another post in our Financial Discrimination, Access, and Equality series. We will continue to share information about how to recognize and help combat financial discrimination, so please come back to read future posts.

It’s no secret that we Americans love our cars. Much of our taxpayer-funded transportation infrastructure centers on privately owned automobiles—consider the location and design of our shopping centers, subdivisions, and office parks. The necessity of owning a car to participate in so much of American life presents a cruel paradox—if you can’t afford a car, you may not be able to get and hold a job that will allow you to afford a car.

That’s one reason people are so willing to take on debt when purchasing a car. In the absence of widespread public transit options outside dense urban areas, auto loan debt is often considered a necessary investment in one’s financial future. But because access to credit can be prone to racial discrimination and the automobile purchasing process can enable bias against non-white car buyers, people of color often have a much more difficult time buying the car they need to not just move around, but move up the economic ladder.

Racial minorities are often charged higher interest rates on auto loans, pay higher average prices for cars, and face more pressure to buy add-ons (i.e., extended warranties) than white borrowers. In fact, people of color were offered more expensive loans than white borrowers 63 percent of the time, despite being more qualified, according to a 2018 study by the National Fair Housing Alliance (NFHA) using matched pair testers.

When it comes to auto lending, decades of public policy and infrastructure funding decisions, their impact on private investment, discretionary dealer markups, and the legacy of racial discrimination disproportionately hurt communities of color. But the playing field does start to level more when you understand the dynamics at work and learn how to choose an auto loan carefully.

You need to be mobile

Throughout much of the 20th century, U.S. infrastructure policies favored massive investment in highways over public transit, and land use policies supported suburban sprawl and single-use developments. Seventy-eight percent of federal transportation dollars were spent on highways from 1956 to 2017, according to federal data cited by a 2019 U.S. PIRG Education Fund report.

As anyone with a commute knows, the ability to drive gives you access to a wider range of employment opportunities, especially if you don’t do the type of work that can be done remotely. Even in New York City, with its extensive subway system, only 15 percent of jobs are accessible within an hour via public transit, while 75 percent are accessible within an hour by car.

The ability to hop in your car and drive when and where you want can not only earn you money, but it could save you money and help you be healthier. For example, many poor people, often minorities, live in communities that lack adequate supermarket access and are described as “food deserts”, where food options are less healthy and more costly.

The result is clear: Without physical mobility, you’re more likely to lose social mobility and fall behind. However, mobility often requires the purchase of a car. And for that, you may need to take on auto loan debt.

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Discrimination in auto loans and car purchases

A 2019 study titled “Discrimination in the Auto Loan Market” (that controls for characteristics like location, income, and creditworthiness of borrowers) estimated that 80,000 non-white borrowers are denied car loans every year solely based on race. Minorities who are approved for auto loans, the study found, pay higher interest rates, a higher sale price for the vehicle, and face more pressure to buy extended warranties or other add-ons (and pay more for those, too).

According to the study, minorities pay 70 basis points more for their auto loans than comparable white borrowers, as if their credit scores were 37 points lower than they actually are. White borrowers, meanwhile, tend to be presented with 75 percent more financing options than minority borrowers. The 2018 NFHA study cited earlier found that its non-white testers (posing as car buyers) would have paid $2,662.56 more over the life of the loan, on average, than less-qualified white testers.

But it doesn’t end after the car is driven off the lot. Minorities also are often charged higher insurance premiums and have a higher likelihood that their driver’s license could be suspended due to civil fines that have nothing to do with driving, according to a 2019 study by the National Consumer Law Center (NCLC).

When combined with other forms of credit discrimination, bias in auto loan origination and auto sales help to reinforce the barriers to financial equity that have impacted people of color for generations. The reasons are varied and complex, but are fueled by the tremendous amount of discretion dealers have when selling cars and the relatively opaque nature of the sales and financing process.

Dealer markups and no transparency

If you buy a washing machine from Walmart, you pay the price on the tag. But the price you pay for a car is not usually the one on the sticker. This discretion in the car sales process opens the door to discriminatory practices, even if only due to unconscious bias.

Dealers also receive kickbacks for interest rate markups, which averaged 2.47 percent in 2009, or $714 per consumer, according to the Center for Responsible Lending. It works like this: a third-party lender will bid for the loan, based on the borrower’s financial information, but the dealer will cite a higher rate. When the loan is approved, the dealer will pocket the difference between the higher-cost loan sold to the borrower and the lower-cost loan terms purchased by the third-party lender.

The NCLC estimates that African American borrowers pay an additional $300-$500 more for car loans than similarly creditworthy white borrowers, while African Americans and Latinos were sold add-ons at nearly twice the rate of white car buyers. Minorities are also charged higher prices for these add-ons. In one example, a dealer who paid $500 wholesale for a window etching product charged between $349 and $5,000 for the same product, with minority customers typically paying the higher amount.

Source: National Consumer Law Center

A crucial problem in auto lending is the lack of enforcement of current laws and regulations. The Consumer Financial Protection Bureau (CFPB) issued a bulletin in 2013 explaining interest rate markups and providing guidance that these third-party lenders must comply with the Equal Credit Opportunity Act (ECOA). This bulletin was rescinded by the Trump Administration in 2018, but the ECOA still applies—even if its actual enforcement is in question.

Compare, for example, how the mortgage industry functions. Federal law requires mortgage lenders to record the ethnicity, race, gender, and gross income of borrowers. Auto lenders do not have the same requirement. This lack of visibility makes it much harder to enforce the applicable laws. In the absence of official data, auto loan discrimination is often only revealed by hard work from researchers who cross-reference multiple databases or employ undercover testers who pose as car buyers.

Denied a loan

Two similar customers of different races paying different prices and interest rates for the same car is one thing, but what happens when people of color are totally denied an auto loan? Similar to the results in the student loan market that disproportionately affect minorities (especially African Americans), minority borrowers often resort to predatory loans or other types of exploitative loans when denied financing from more traditional sources.

If you can’t secure a mortgage, you can always rent. But if you can’t pay for a car or get an auto loan to buy one, the resulting lack of mobility can have far-reaching consequences on income and quality of life. Having reliable transportation to get to a job is a powerful motivator to purchase an automobile and take on even unsustainable auto loan debt.

Ways to protect yourself when seeking an auto loan

So, what should minority borrowers do to help protect themselves from discriminatory lending and sales tactics? Shopping at minority-owned auto dealerships or working with a non-white dealer may help, but discrimination is often more institutional and, as discussed above, difficult to detect. However, the following tips may help avoid the tactics most often used by auto dealerships to take advantage of customers.

Get pre-approved for a loan

Certain dealerships that offer in-house financing target individuals with poor credit, using slogans like “Bad credit? No problem!” to lure customers. Those pushing easy credit typically sell expensive loans that most of their target customers can’t repay, positioning themselves as the buyer’s only option. They also may employ other tactics, such as pushing add-ons you may not need or be able to afford.

Instead, go to a bank or credit union and get pre-approved for a loan. You also may be able to find favorable auto loans online from companies like Lending Tree or Carvana, which are reportedly less discriminatory in their lending practices. That way, you may be able to avoid interest rate markups and focus on getting a fair price for the automobile.

Avoid “yo-yo” financing

One deceptive financing tactic sometimes used by auto dealers is to contact the car buyer after they’ve already signed the documents and driven the car off the lot, telling them the financing actually wasn’t finalized. The buyer may be shown another set of financing documents with a higher interest rate or requiring an additional down payment. This is called “yo-yo” financing.

The dealer may falsely claim that you will lose your down payment and approval for a loan if you decline. Your best protection against yo-yo financing is to ask for the Truth in Lending Act disclosures for your transaction. Never finalize your documents until you get confirmation that financing has in fact been approved.

Don’t focus only on low monthly payments

Low monthly payments can be a good thing, especially if they fit your monthly budget. But they also can mask an unnecessarily expensive loan, often with an extended lifespan that may even outlive your car. You don’t want to still owe money on a car when it comes time to trade it in for a new one, especially if it results in negative equity, also known as being “upside down.” Take a look at the whole picture by considering all of the following:

• The duration of the loan

• The interest rate

• The full cost of the car

After understanding the full auto loan debt you will have, you may decide to go with a less expensive vehicle. One other option is purchasing a car from a verified online car marketplace, many of which are rated by Consumer Affairs.

Be suspicious of add-ons

Some add-ons might make sense, depending on your needs and your ability to pay for them, but be prepared for the hard sell. Dealers may try to use fear tactics to get you to buy an add-on, such as suggesting a worst-case scenario for those who don’t buy the extended warranty. They push add-ons because that’s how they make much of their commission.

Some add-ons are much cheaper if purchased elsewhere, while many of them are unnecessary. According to Autotrader, add-ons that should almost always be avoided include VIN etching (marketed as a theft-protection tool), rust-proofing, fabric protection, and extended warranties.

Above all, when you go to any dealership, make sure you’re armed with knowledge, trust your instincts, and are ready to walk out if you feel pressured.

Protect your mobility and your financial future

Eliminating the discrimination that affects too many consumers will require a long-term commitment by our society. Freedom Debt Relief doesn’t have all the answers, but we will continue to provide information about these kinds of financial challenges so you can avoid the common pitfalls when dealing with issues like auto loan debt. Please come back to our blogs for updates and to learn more about your rights and financial options.

Learn More

• What Minority Car Buyers Can Do to Avoid Discrimination (Consumer Reports)

• What You Should Know About Mortgage Discrimination (Freedom Debt Relief)

• Auto Add-Ons Add Up: How Dealer Discretion Drives Excessive, Arbitrary, and Discriminatory Pricing (National Consumer Law Center)

• Access to Banking: What Does Underbanked Mean? (Freedom Debt Relief)

• What should I do if I think that a lender or auto dealer discriminated against me in my auto loan application? (Consumer Financial Protection Bureau)