While it remains very hard to get a mortgage, there seems to be plenty of money for car loans. But keep in mind that, just like mortgages, not all car loans are alike. And just like mortgages, there are predatory car loans that end up making a vehicle a lot more expensive.
How do you know if the loan you are being offered is predatory? The Center for Responsible Lending says there are five red flags consumers should look for.
Car dealers usually have deals with lenders. The lender agrees to a low “buy rate” but allows the dealer to raise it at the dealer's discretion. The dealer often will do that since most of the additional interest ends up in the dealer's pocket.
Loan packed with Junk fees
Dealers inflate the overall price of the car loan through overpriced add-on products – often sold in packages –including “GAP” insurance, vehicle service contracts, credit life and disability insurance, rust proofing, theft deterrent packages, and “window etching.” By inflating vehicle cost, the dealer is inflating the loan size. As a result, the potential loan kickback for the dealer is increased.
The buyer is either convinced to enter into or unwittingly placed in a conditional sale agreement rather than a final sale. After the buyer drives the vehicle home, the dealer later claims to be unable to fund the loan at the agreed-upon terms. The buyer is required to return the car and renegotiate an often more costly loan. Often, the buyer is told that their down payment is non-refundable and/or their trade-in has already been sold.
Buy Here, Pay Here
Buy Here Pay Here (BHPH) dealerships typically finance used auto loans in-house to borrowers with no or poor credit histories. The average APR is much higher than a bank or credit union loan. BHPH dealers expect much higher default and repossession rates.
Instead of responsibly financing affordable cars, the business model depends on churning the same vehicles to local buyers as many times as possible. Dealers usually require a disproportionate percentage of the car’s actual value for down payment and pack the loan with unnecessary fees to make more money up front.
No option to sue
“Mandatory arbitration” clauses essentially waive the customer’s right to sue and appeal in court. In simple terms this means that if you have a valid complaint with a car dealer, you won’t be allowed to take action through a court of law. Instead, companies require their customers to pursue complaints through an arbitrator—a process that is more likely to favor the dealer.
One of the best ways to avoid predatory loans is to avoid financing the vehicle through the dealer, period. Instead, get pre-approved for the loan at your bank or credit union. To avoid a yo-yo sale, read the contract carefully to make sure it is a final, not a conditional sale. To keep from inflating the value of the car, say no to the add-ons you don't really need.
Remember, the saleman may be very persuasive but the consumer holds the ultimate power on a car lot. If you are prepared to walk away from a bad deal, you will find that very few salesmen will let you walk without giving ground.