Car finance

History

Car financing started with the General Motors Acceptance Corporation circa World War 1.

Car purchases

The most common method of buying a car in the United States is borrowing the money and then paying it off in installments. Over 85% of new cars and half of used cars are financed (as opposed to being paid for in a lump sum with cash).

There are two primary methods of borrowing money to buy a car: direct and indirect. A direct loan is one that the borrower arranges with a lender directly. Indirect financing is arranged by the car dealership where the car is purchased. Legally, an indirect “loan” is not technically a loan; when a car buyer obtains financing facilitated by a dealership, the buyer and dealer sign a Retail Installment Sales Contract rather than a loan agreement. The dealer then typically sells or assigns that contract to a bank, credit union, or other financial institution. Usually, the dealer knows in advance which financial institution will buy the contract. The borrower then pays off the financial institution the same as for a direct loan. Typically, the indirect auto lender will set an interest rate, known as the "buy rate". The auto dealer then adds a markup to that rate, and presents the result to the customer as the "contract rate". These markups have been the focus of some regulatory scrutiny because they can cause variations in interest rates that are not correlated with credit risk.

Car financing options in the United Kingdom similarly include car loans, hire purchase, personal contract hires (car leasing) and Personal Contract Purchases.

In 2016, Toyota was found guilty of racist lending practices.

Dealer financing

Dealer financing, also known as indirect auto lending, is a common method offered by automobile dealerships to customers purchasing vehicles. In this arrangement, the dealership acts as an intermediary between the buyer and a third-party lender, such as a bank or finance company, and facilitates the loan on the buyer’s behalf. This process allows customers to secure financing at the point of sale rather than arranging it independently in advance.

Dealer-arranged financing is a significant source of revenue for dealerships. According to the National Automobile Dealers Association (NADA), roughly 75–80 percent of new vehicle sales in the United States involve some form of dealer-arranged financing. Dealers typically receive compensation in the form of a “dealer reserve” or markup, the difference between the interest rate set by the lender (the “buy rate”) and the rate presented to the consumer (the “contract rate”).

While convenient, dealer financing may not always be the most cost-effective option for buyers. Several studies and consumer protection agencies have noted that dealer markups can result in higher overall interest costs compared to direct lending from banks or credit unions. For instance, research has found that vehicles financed through dealerships may carry, on average, hundreds of dollars in additional costs due to financing markups or add-on products such as service contracts, gap insurance, or extended warranties.

Regulatory scrutiny has occasionally focused on discriminatory or unfair lending practices in dealer-arranged financing. In several cases, investigations by the U.S. Department of Justice and the Consumer Financial Protection Bureau (CFPB) have resulted in settlements with lenders over allegations that discretionary dealer markups led to higher interest rates for minority borrowers.

Car leases

Main article: Vehicle leasing

A lease is a contractual agreement between a person who owns the property (lessor) and a person who gets to use it during the term of the lease (lessee). Usually, car leases allow the lessee to drive the car for a certain number of miles for a certain number of years. The lessee pays a fixed monthly payment for the privilege of driving the vehicle, and when the lease ends, the lessee returns the vehicle to the lessor. The lessee pays only for the value of the vehicle for the term of the lease. Lenders calculate lease payments based on the vehicle’s residual value, or what they estimate the car will be worth when the lease is over.

Spot delivery

Main article: Spot delivery

Spot delivery (or spot financing) is a term used in the automobile industry that means delivery of a vehicle to a buyer prior to financing on the vehicle being completed. Spot delivery is used by dealerships on the weekend or after bank hours to be able to deliver a vehicle when a final approval cannot be received from a bank. This method of delivery is regulated by many states in the U.S., and is sometimes referred to as a "Yo-Yo sale" or "Yo-Yo Financing".

References

References

1. "Car Loan".
2. (14 July 2015). "CFPB and DOJ Reach Resolution with Honda to Address Discriminatory Auto Loan Pricing - Consumer Financial Protection Bureau".
3. (2 February 2016). "Toyota Motor Credit settles with U.S. Over racial bias in auto loans". Reuters.
4. "Understanding Indirect Auto Financing". U.S. Government.
5. (2023). "NADA Data 2023: Annual Financial Profile of America’s Franchised New-Car Dealerships". National Automobile Dealers Association.
6. (7 February 2022). "What Is a Dealer Reserve?".
7. (21 March 2013). "Indirect Auto Lending and Compliance with the Equal Credit Opportunity Act".
8. "Car Loan Interest Rates and Dealer Markups Explained".
9. Chakrabarti, Rajashri. (18 November 2020). "How Auto Financing Affects the Car Market". Federal Reserve Bank of New York Liberty Street Economics.
10. (20 December 2013). "Justice Department and Consumer Financial Protection Bureau Order Ally to Pay $98 Million to Address Discriminatory Auto Loan Pricing". U.S. Department of Justice.
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12. (20 June 2016). "Spot delivery is a bad idea when buying a car". ABC 15 Arizona.
13. (24 November 2014). "Yo-Yo Sales: For Subprime Borrowers, Car Contracts With Many Strings Attached". International Business Times.
14. (18 April 2012). "Consumer Advocates Seek Halt to 'Yo-Yo' Car Financing". The New York Times.