Dealer financing prompts scrutiny

One in 4 Americans who finances a new or used car through a dealership ends up paying a higher interest rate than their credit record calls for, according to the Consumer Federation of America (CFA). Those most frequently tagged with the markups: Hispanics and African-Americans, the group says.

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That charge - fiercely contested by auto dealers and finance companies - highlights a little-known area of the car-purchase process. When consumers finance their purchase through a dealer, the dealer typically makes additional money.

"These hidden finance kickbacks typically add at least $1,000 to the cost of an auto loan, and are costing consumers as much as $1 billion annually," says Steve Browbeck, CFA executive director. "We consider it an unfair practice. And I think any consumer would be against this."

The process isn't illegal, just not advertised. Typically, a dealer offers to finance the car at a certain rate, then shops the loan around to banks or finance companies to find the lowest rate, says Greg Merryman, an attorney with General Motors Acceptance Corp., the automaker's financing arm. The dealer pockets the difference between the bank's lower rate and the customer's higher rate.

The National Automobile Dealers Association (NADA) compares it to purchasing a hamburger. McDonald's pays a certain amount of money for a hamburger and the consumer later pays more for it. The markup is undisclosed, but the price is still assumed to be fair.

"Even with the markup, dealers, because they deal in such volume, can many times still provide the lowest finance rate to customers," the association says in a statement.

But minorities are unfairly targeted by the practice, the CFA report charges. The organization cites studies from 2001 and 2003 by Mark Cohen, a Vanderbilt University professor, that reported black GMAC customers were charged $412 more than those who were white, and Hispanic customers of Nissan Motors Acceptance Corp. were charged $305 more than whites.

"There needs to be a change in the lending industry," says Brenda Muniz of the National Council of La Raza, a Hispanic advocacy group in Washington. "They need to take steps to make an environment that is conducive to fair and open trading."

Lenders deny racial bias. "Race has nothing to do with our transactions," says Dan Jarvis, media-relations manager for Ford Credit. "When we make offers to buy consumer contracts, we base that on objective credit history, income-to-debt ratio, and the ability of the customer to make payments.... All we see are numbers on a screen. We tell the dealer 'yes' if the numbers show the customer is creditworthy."

The key, industry observers say, is that consumers should shop around for auto loans - including from sources besides the dealer.

"I would say the majority of the car loans are marked up from what the bank has approved," says J.A. Watson, automotive consultant and consumer advocate based in Humble, Texas. "It's been three percentage points ... for years.

Mr. Watson says steering clear of unscrupulous lenders means taking an active role in the process. The Internet offers a range of automobile buying websites aimed at helping car buyers, he says. "And people need to explore these."