Under the Hood: Auto Loan Interest Rate Hikes Inflate Consumer Costs and Loan Losses

Abstract

Markups on auto loan interest rates are routinely used to compensate a dealership for the service of securing financing with a third party lender. However, rate markups add percentage points to the rate a consumer would legitimately qualify for, and are added without the adequate disclosure to the consumer. Such a dynamic creates a "reverse competition" environment where the dealer's service only increases the cost to consumers, never decreasing it. Our research analyzes automobile asset backed securities and data from multiple auto industry sources to examine the scope of auto rate markups and their impact on loan performance. We conclude that rate markups on auto loans lead to more expensive loans and higher odds for default and repossession for subprime consumers. As a result, the report recommends divorcing all dealer compensation from the manipulation of the interest rate.

Keywords: auto loan, interest rate, markups, delinquency, repossession

JEL Classification: D18