The Automobile Lending Market and Policy Issues
April 25, 2019
The Automobile Lending Market and Policy Issues
An automobile (auto) loan allows a consumer to finance the
restricts such practices in the mortgage market, after reports
purchase of a new or used car. In most parts of the United
of mortgage brokers steering customers to more expensive
States, access to a car is critical for people to be able to get
loans due to “kickbacks”—unearned fees for a referral—in
to work and other important activities. According to Kelley
the lead-up to the financial crisis, Congress in 2010 took
Blue Book, a vehicle valuation and research company, the
actions to further crack down on these practices.
average cost of a new car was more than $36,000 in 2018.
Most people cannot pay such a large amount in cash. For
Alternatively, consumers can also go directly to a bank,
this reason, many people choose to finance the cost of a car.
credit union, or other lender for an auto loan, before making
their purchase, avoiding the dealer markup cost. Different
The auto loan market is the third-largest consumer credit
consumers may prefer arranging auto financing through an
market in the United States, after mortgages and student
auto dealer or directly through a lender, depending on their
loans. According to the New York Fed, at the end of 2018,
preferences around convenience, cost, and other factors. In
113 million consumers—roughly 45% of adult
either case, the lender usually owns the loan and can service
Americans—had an auto loan and auto loan debt
it themselves or through a third-party company.
outstanding totaled almost $1.3 trillion. This In Focus
provides a brief overview of the auto lending market,
Some auto dealerships extend credit themselves, called
explains how the market is regulated, and analyzes related
“Buy Here, Pay Here,” commonly marketing to consumers
policy issues.
with subprime or no credit history. These dealers do not
work on behalf of other lenders, but keep the loan on their
Overview of the Auto Lending Market
books. These dealers tend to offer higher interest rates and
Auto loans are usually structured as installment loans,
more expensive loans to consumers.
where a consumer pays a fixed amount of money each
month for a predetermined time period, frequently three to
If a consumer cannot pay cash for a new or used car, the
seven years. Often, lenders require consumers make a down
consumer also has the option to lease the car. In a leasing
payment to obtain the loan. Auto loans are secured by the
arrangement, the consumer pays for the right to drive the
automobile, so if a consumer cannot pay the loan, the lender
car for a fixed period of time, often three years. Unlike an
can repossess the car to recoup the cost of the loan.
auto loan, the consumer does not own the car. Leasing
arrangements are not considered consumer loans and,
Reportedly, most auto loans are arranged at the auto
therefore, are not regulated like auto loans.
dealership where the car was purchased, called the indirect
auto financing market. The dealer forwards information
Auto Market Regulation
about the prospective borrower to one or more lenders, and
In response to the financial crisis, the 2010 Dodd-Frank
solicits potential financing offers. Often, the dealer is
Wall Street Reform and Consumer Protection Act (Dodd-
compensated for originating this loan through a
Frank; P.L. 111-203) established the Bureau of Consumer
discretionary markup, which is the difference between the
Financial Protection (CFPB) to implement and enforce
lender’s interest rate and the rate that a consumer is
federal consumer financial law while ensuring consumers
charged. The lender may cap the possible size of the dealer
can access financial products and services. The CFPB’s
markup (e.g., 2.5%) to limit the loan from becoming too
authorities fall into three broad categories: supervisory,
susceptible to default. But within this range, auto dealers
including the power to examine and impose reporting
and consumers can negotiate the loan’s interest rate, and
requirements on financial institutions; enforcement of
therefore indirectly determine how much to compensate the
various consumer protection laws and regulations; and
auto dealer for the convenience of arranging the loan.
rulemaking, to prescribe regulations to implement
consumer protection laws. The CFPB is the main federal
In the indirect auto financing market, the dealer markup
regulator for the auto loan market, overseeing consumer
arrangement can incentivize the auto dealer to negotiate—
protection compliance. If a bank or credit union owns auto
and profit from—a higher interest rate with the consumer.
loans on its books, that bank is also subject to safety and
The auto dealer may also choose the lender who
soundness regulation from other financial regulators,
compensates it the most—for example, the lender that
depending on its charter. For more information, see CRS In
allows the largest markup, rather than the lender offering
Focus IF10031, Introduction to Financial Services: The
the best terms for the consumer. Although other consumer
Bureau of Consumer Financial Protection (CFPB), by
credit markets include markups, it is less common for bank
Cheryl R. Cooper and David H. Carpenter.
or credit union lenders to allow an outside broker in the
transaction discretion as to the amount of the markup. For
The CFPB oversees consumer protection compliance for
example, while the Real Estate Settlement Procedures Act
auto lending, but not auto dealers’ typical activities. Dodd-
https://crsreports.congress.gov
The Automobile Lending Market and Policy Issues
Frank states that the CFPB “may not exercise any
in indirect auto lending markets. Auto lenders generally do
[authority] over a motor vehicle dealer that is
not collect information on the race or ethnicity of
predominantly engaged in the sale and servicing of motor
borrowers. Using a new proxy methodology, a statistical
vehicles, the leasing and servicing of motor vehicles, or
method developed for estimating race, the CFPB generally
both.” Given the major role that auto dealers play for
alleged that these institutions violated ECOA by permitting
consumers in dealer-arranged financing, Congress
their dealers to charge markups that resulted in disparate
continues to debate the scope of the CFPB’s regulatory
impacts on the basis of race and national origin. In general,
jurisdiction over auto dealer activities.
as part of the consent orders these institutions did not admit
or deny the allegations but, among other things, paid
Among other laws, the CFPB is responsible for enforcing
monetary penalties and agreed to limit their markups to
the Equal Credit Opportunity Act (ECOA; 15 U.S.C.
reduce these disparities.
§§1691-1691f), which generally prohibits discrimination in
credit transactions based upon certain protected classes,
The CFPB’s indirect auto lender guidance and the resulting
including an applicant’s sex, race, color, national origin,
enforcement actions were controversial. Some argued that
religion, marital status, age, and “because all or part of the
the guidance overstepped Congress’s intent in excluding
applicant’s income derives from any public assistance
auto dealers’ typical activities from the CFPB’s regulatory
program.” ECOA historically has been interpreted to
jurisdiction in Dodd-Frank. Others argued that the markup
prohibit both intentional discrimination and disparate
disparities were justified by legitimate business reasons. For
impact discrimination, in which a facially neutral business
example, auto dealers sometimes initially retain some
decision has a discriminatory effect on a protected class.
default risk before transferring it all to the lender, which
However, the Supreme Court’s reasoning in a June 2015
may explain some of the markup disparities. Yet, the CFPB
decision involving the Fair Housing Act, another federal
argued that a change in indirect auto lenders’ business
antidiscrimination law, has sparked debate about whether
models could reduce disparities while still being profitable
disparate impact claims are covered under ECOA. For
for auto dealers by allowing, for example, a flat fee to the
background on disparate impact claims, see CRS Report
dealer for arranging the loan. Moreover, because the CFPB
R44203, Disparate Impact Claims Under the Fair Housing
issued guidance, rather than a formal rule, without
Act, by David H. Carpenter.
providing time to comply, some believed that the
enforcement actions were unfair. In 2018, Congress
Policy Issues
rescinded the CFPB’s indirect auto lender guidance
This section highlights selected policy issues of
pursuant to the Congressional Review Act (P.L. 104-121).
congressional interest in the auto finance market. In
Nevertheless, some observers argue that this policy issue
general, these policy debates concern the appropriate
continues to be an area of concern in the market.
balance between consumer protection, convenient credit
access for consumers, and costs to industry.
Regulatory Exclusion. As previously mentioned, Dodd-
Frank expressly excluded auto dealing, servicing, and
Consumer Awareness and Ability to Negotiate Auto
leasing from the CFPB’s regulatory jurisdiction. The scope
Loan Terms. According to CFPB research, unlike car
of this exclusion continues to be controversial, given the
prices, consumers are not always aware that they can
key role auto dealers play in originating auto loans for a
negotiate the terms of an auto loan when obtaining dealer-
large part of the market. Auto dealers argue that because
arranged financing. For this reason, many consumers do not
they are facilitating, not originating, auto loans—and their
shop for auto loans. Consumers’ lack of awareness—
primary role is buying and selling cars—it is inappropriate
combined with auto dealers’ discretion on markups—may
to subject them to consumer financial protection
make consumers vulnerable to bad actors in this market and
regulations. Conversely, consumer advocates believe that,
make the auto loan market uncompetitive. Some observers
without direct government oversight, consumer protection
believe that financial education programs may be one way
violations will take place more frequently.
to raise consumer awareness of their right to negotiate the
terms of an auto loan.
Longer Auto Loans Maturities. According to the CFPB,
26% of auto loans originated in 2009 matured in six or
Fair Lending and Indirect Auto Lenders. In 2013, in
more years, whereas such loans constituted 42% of
response to concerns that auto dealer markups could result
originations in 2017. While this trend has been attributed in
in pricing disparities based on protected classes, the CFPB
part to rising vehicle costs and consumers retaining their
issued a controversial bulletin providing guidance to
cars longer, these factors may not fully account for the
indirect auto lenders on how to comply with ECOA. This
trend. If consumers are keeping their cars for longer periods
guidance generally stated that indirect auto lenders should
of time, perhaps due to better vehicle technology, then
impose controls on or revise and monitor dealer markups to
longer loan terms may just reflect this improvement.
ensure they do not result in disparate impact based on race
However, if a consumer is ready to trade in for a new car
or other protected classes.
before the end of the loan term, the consumer may owe
more on the car loan than the vehicle is worth, called
From 2013 to 2016, the CFPB, in coordination with the
negative equity. Greater negative equity makes loans more
Department of Justice, issued consent orders to settle
susceptible to default. Notably, negative equity in the auto
enforcement actions against American Honda Finance
trade-in market has been increasing and is a common cause
Corporation, Toyota Motor Credit Corporation, Fifth Third
of consumer complaints to the CFPB.
Bank, and Ally Financial & Ally Bank for ECOA violations
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The Automobile Lending Market and Policy Issues
IF11192
Cheryl R. Cooper, Analyst in Financial Economics
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