Warding off bias claims by shedding light on dealer reserve

Of the three parties that share a financial stake in an auto loan arranged at a dealership, typically only two know exactly how the interest rate breaks down: the dealership and the lender.

Most car buyers are in the dark when it comes to the bit of interest that the dealership likely has added to their loan, known as the dealer reserve. Lenders allow dealerships to add interest to auto loans as a way of compensating them for arranging the deal. The lender pays the dealership from the revenue gained by the rate increase.

But car buyers need to be told right away whether their interest rate includes a dealer reserve. And if it does, the dealership should tell the car buyer not only the amount of the reserve vs. the lender’s buy rate but also that it will receive a payout from it.

Transparency on interest rates could help dealerships and lenders ward off discriminatory lending allegations.

Most car buyers don’t know about the dealer reserve so they don’t try to negotiate the added interest down. They assume the rate quoted to them by the dealership is the lender’s buy rate.

For example, I spoke with an Ally Financial borrower who received a letter saying he could be eligible to receive money from the lender’s settlement with the Consumer Financial Protection Bureau and U.S. Department of Justice over allegations of discrimination in auto financing.

He said that when the loan was arranged, he was unaware that the dealership had added to the interest rate. He also said he didn’t negotiate; the dealership told him his rate was the best it could do as he was a first-time car buyer, so he “rolled with it and assumed it was fair.” Now, though, he’s hoping to get it lowered.

At least this time, he’ll know to ask about the dealer reserve, and he may even feel comfortable about negotiating it down, ultimately coming away with what he -- and perhaps regulators -- believes is a fairer deal.

Dealerships deserve compensation for arranging loans. But if it comes by way of dealer reserve, dealerships must be transparent with car buyers about where their money is going.

You can reach Hannah Lutz at hlutz@crain.com

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