March 5, 2001
"My
cousin financed his car through the car dealer and is now involved in a
class action suit against the lender�
As I read about how car dealers arrange financing, it strikes me
that they operate just like mortgage brokers.
Am I right?"
Largely.
While there are many differences between mortgage brokers and the
financing arm of car dealers, these are less important than the
similarities. The potential
for abuse is essentially the same. Class
action suits against lenders in both industries make essentially the same
allegation: that the lenders allowed the dealers/brokers to collect
excessive charges from the borrower.
Both
car dealers and mortgage brokers are loan finders; they do not lend their
own money. Both maintain
relationships with multiple lenders.
The major service they provide to the consumer is accessing
lenders.
One
difference is that mortgage brokers usually deal only with mortgages while
dealers also offer such �extras� as accident and health insurance,
life insurance and warranties. A
second difference is that finding the right loan is usually much more work
for a mortgage broker. There
are many more loan programs and options from which to choose, and the
qualification requirements and pricing are much more complex.
Both
brokers and dealers receive competitive prices from lenders, who must
compete with each other for their business.
This part of the market process works well.
Both
brokers and dealers add a markup to the wholesale price, which is what
they make on the deal. This
part of the market process does not work nearly as well.
The
broker marks up the points. Points
are an upfront charge expressed as a percent of the loan; one point is 1%
of the loan. For example, if
the lender quotes 8% and 1 point on a $200,000 loan and the broker adds 1
point, the borrower pays a total of $4,000, of which $2,000 goes to the
broker.
Car dealers
mark up the interest rate, but are paid for the higher rate by the lender
as if the rate increase was points. For
example, if the lender quotes a 12% rate on a $20,000 car loan and the
dealer marks it up to 14%, the lender will pay the dealer 2% of $20,000,
less a small reserve that the lender retains to cover early repayments.
The
markup process has significant potential for abuse in both markets.
While some brokers/dealers try to standardize their markups, others
charge as much as they can get away with in each case.
The result is that markups vary widely, and the variations have
little to do with the amount of work required of the broker or dealer.
Most
brokers and dealers try to keep their markups to themselves.
Mortgage brokers are required by law to disclose their markups, but
usually this happens too late in the lending process to do the borrower
any good. Car dealers need
not disclose their markups ever.
Both
brokers and dealers feel it is unjust to require them to disclose markups.
�Grocery stores need not disclose their markups, so why should
we?� Their argument
overlooks that consumers become expert at shopping for groceries because
they do it so frequently, and prices are easily compared between stores.
Consumers take mortgage loans and automobile loans infrequently,
and shopping alternatives is difficult.
Nonetheless,
alert consumers can avoid excess markups.
Consumers in both markets can check quoted prices for
reasonableness on the internet.
Borrowers in the car loan market can use the Annual Percentage Rate
(APR), a comprehensive measure of the cost of credit, as an effective
shopping comparison tool. Interest
rates on car loans are also much more stable than mortgage loan rates.
But borrowers must resist the temptation to go from the automobile
table to the loan table without exploring other loan options.
Shopping
mortgages is more difficult because the market changes so frequently and
pricing is much more complex. Furthermore,
borrowers can�t depend on the APR as a guide unless they confidently
expect to be in their house at least 10 years.
Borrowers can avoid these problems, however, by retaining an
Upfront Mortgage Broker (UMB) who discloses the markup in advance, and
then acts as the agent of the borrower in finding the best deal.
For a list of UMBs, click here.
Copyright
Jack Guttentag 2002
