Vehicle financing problems

How car dealers fraudulently manipulate the interest rate of a loan

Another type of auto fraud related to the vehicle's financing is when the dealer incorrectly discloses the financial terms of the loan. This dishonest practice is designed to dupe the buyer into thinking that the loan is more favorable than it really is.

Under the Truth in Lending Act, the dealer must accurately disclose the amount financed, the finance charge, and the annual percentage rate. Federal law requires that these terms be disclosed in the so-called Truth in Lending box (pictured above). The main point of the Act is to require transparent and consistent disclosure of finance terms so that buyers can easily compare multiple loans and decide which one is best.

Here's what the key terms mean:

Amount Financed. This is the total amount of money you are borrowing from the lender.

Finance Charge. These are all of the charges imposed as a result of the extension of credit. This obviously includes interest, but should also include any other charge that a buyer would not have to pay if it was a cash transaction.

What a shady dealer might do is to manipulate these disclosures to distort the true cost of the credit. The most common way a dealer does this is add a finance-related charge to the "Amount Financed" total rather than the "Finance Charge" total. This little trick will make the interest rate look lower than it really is.

Here's an example. Let's say you're buying a used car for $10,000. The annual interest rate is 10% and you will pay it off over 5 years (60 months). So the $10,000 would go in the Amount Financed box because it's the amount you're borrowing. And the interest amount ($2,621.25) would go in the Finance Charge box.

Because you're financing the transaction, the dealer requires that a GPS unit be installed so that it can locate the vehicle for a repossession if you fall behind on payments. The dealer charges you $500 for the GPS unit. Because the dealer allows you to roll this $500 charge into your loan, it goes in Amount Financed box right? Wrong. The GPS fee should be a Finance Charge because the dealer only requires these GPS units for buyers that finance. It doesn't require them for cash buyers. By fraudulently putting the GPS fee into the Amount Financed box, the dealer keeps the APR at 10%. But if the GPS fee was put in the Finance Charge box where it belongs, the APR jumps to 12.33%. You can verify my math if you like by using this online APR calculator.

The takeaway? Make sure you carefully review the terms of your loan to make sure the dealer isn't trying to scam you. Review every charge and ask yourself would the dealer charge this in a cash transaction? If the answer is no, then it should be a finance charge and disclosed accordingly. If the dealer improperly discloses the financial terms or misstates the interest rate, it likely has violated the Truth in Lending Act. This would give rise to claims for statutory damages, actual damages, and the dealer would have to pay your attorney fees and court costs.

Conditional delivery: how car dealers use it to scam buyers

If you've ever bought a vehicle from a dealer and financed the purchase, chances are you signed something called a conditional delivery agreement. If you read this agreement carefully, it states that the dealer has the right to cancel the sale if the dealer can't assign your auto loan to a lender on terms agreeable to the dealer. In other words, if the dealer changes its mind about the deal, it has the right to unwind the transaction. This provision, typically in the fine print of the sales contract, is the source of one of the most widespread auto frauds and applies to both new and used car sales. Here's how the scam works: you agree to buy a vehicle and you fill out a credit application for financing. The dealer tells you that you've been approved for the loan and you sign the loan agreement and other typical sales paperwork, which contains the conditional delivery language. You either don't notice this provision because it's in the fine print or the dealer tells you it's nothing to worry about. So you give them a cash down payment and turn over your trade-in. The dealer gives you the keys to your new car and you drive it home thinking you're all set.

But you're not. A few days later, the dealer calls you and tells you that your financing "fell through" and that you need to bring the vehicle back and sign a new loan agreement. If you complain, they might threaten to repossess your new vehicle or even to call the police and report it stolen. So you go back to the dealership. And you learn that your trade-in has already been sold and that the new loan that they're demanding that you sign has a higher interest rate than the one you originally agreed to. Although you don't want to sign this new agreement, you don't have a choice because your trade-in is gone and they've threatened to repossess your new vehicle and keep your downpayment if you don't agree to the new, less favorable, loan on the spot. You need the new vehicle to get to work and to drive your kids to their activities, so you reluctantly sign the unfavorable new loan.

Dealers call this practice conditional delivery or spot delivery. Consumer advocates call it a "yo-yo" scam. Either way, it's a blatantly unfair and one-sided practice. The dealer doesn't want you to think about the deal overnight, it wants the deal closed on the spot. On the other hand, the dealer wants to keep its options open after you've driven the car off the lot. It doesn't want to be rushed into a hasty deal. The conditional delivery agreement makes the deal final for the buyer, but not for the seller.

Sometimes the yo-yo scam is simply the dealer re-thinking the terms of the sale after the fact. Other times, it's a deliberate scheme from the beginning to inflate the finance costs. There's evidence that dealers target customers with poor credit or low income. In other words, dealers use the yo-yo scam to rip off people who can least afford to be ripped off.

Although the conditional delivery provision in the contract gives the dealer some legal cover, there are ways to attack this unfair practice through a lawsuit. If you've been a victim of a yo-yo scam, you should discuss the situation with an attorney right away.

When Buying a Used Car, Watch Out for Worthless Service Contracts

Buy a new or used car these days and you can expect the salesperson to pressure you to buy a service contract or "extended warranty." For a fee, which is usually rolled into the financing, these products provide repairs or maintenance for a certain period of time, say 2 years or 24,000 miles. But they rarely provide much benefit to the buyer and often only serve to pad the dealer's bottom line.

Here's an example of what I mean. In a recent case, our client bought a used vehicle with over 100,000 miles on it. The client also bought a service contract for an additional $2,500 or so. The service contract lasted for 5 years or an additional 100,000 miles. Our client rolled the cost of the service contract into his loan for about $50 a month. At this point, you might be thinking this sounds like a pretty good deal.

However, the fine print of the service contract provided for a maximum reimbursement of only $3,000, less a $100 deductible. So the maximum reimbursement was actually $2,900. Further, a great deal of possible mechanical problems were excluded from coverage.

 So, our client paid $2,500 for the right to be reimbursed $2,900. In other words, he paid $2,500 to potentially receive an additional $400, but only if: (a) a problem occurred; (b) the problem occurred during the term of the service contact and (c) the problem wasn't excluded from coverage. He would have been better of declining the service contract and putting the $50 a month into a savings account. The savings account could have been used for any repair at any time. And if no repairs are necessary, he could have used the money for something else.

Before agreeing to buy any service contract, make sure you understand the total cost (not just the monthly cost), the total amount of coverage, and what is covered and what's not. Don't rely on the salesperson to tell you these things, read the terms for yourself. And if you don't understand the terms, it probably doesn't make sense to buy it.

6 tips if you must buy a vehicle from a buy-here pay-here dealership

The L.A. Times is currently running an investigative series on so-called Buy-Here Pay-Here auto dealerships. The first installment describes the basic business model used by these businesses and identifies a number of the pitfalls of buying a vehicle from them. A buy-here pay-here dealership is, as the name suggests, a dealership that finances the car loans itself, rather than using banks or finance companies. They market to people with low-income and bad credit that can’t qualify for conventional financing. In return for agreeing to finance borrowers that don’t have access to mainstream credit, the buy-here pay-here dealers drastically inflate the price of their vehicles, charge very high interest rates, agree to payment arrangements that they know you can’t honor, and aggressively repossess the vehicle once it’s in default, keeping all of the money that the borrower has already paid. And once the vehicle is repossessed, they sell it again. And again. Sometimes the same vehicle is repossessed and sold as many as eight times, creating another revenue stream for these business. The L.A. Times succinctly–and accurately–describes the business model as “sign, drive, default, repossess, and resell. The entire Times piece is a fascinating look into this booming industry and is definitely worth your time.

It would be too easy to advise everyone to steer clear of buy-here pay-here dealerships. After all, they do allow people without access to mainstream credit to buy a vehicle. And let’s face it, most people need a vehicle to get to and from work these days. But buying a car from them is very, very risky. Here are some tips if you’re considering buying a car from a buy-here pay-here lot:

  • Decide whether you really need to buy from them. Obviously, if you’re considering a buy-here pay-here dealership, you’ve decided that you need a vehicle and have been rejected by conventional lenders. But consider whether you would be better off taking the money that you’ve earmarked for a down payment to the buy-here pay-here dealer and instead using it to buy a used car outright from a private party. This would solve your transportation and financing problem, without taking on all of the risks of buying from a buy-here pay-here dealer.

  • Do your homework on the purchase price. Because the buy-here pay-here dealer knows that you’re desperate, they often inflate the list price well-over the vehicle’s Kelley Blue Book value. The Times story reports about one particular transaction where the purchase price was inflated to double the KBB price. Do your homework and make sure that you are getting a fair price.

  • Review the interest rate carefully. The Times story tells the story of one person who thought she purchased a car with an APR of 12%, when it actually was 20.3%. Make sure that the APR is actually what the contract says it is. There are a number of online APR calculators that you can use to verify the dealer’s numbers.

  • Be sure that you can afford the monthly payment. The Times story reports that 1 in 4 buy-here pay-here customers defaults on their loan. And there is ample evidence that the dealer may deliberately agree to a payment plan that they know you can’t afford because they know that they can just repossess your vehicle and sell it again to someone else. So be conservative in your estimates of how much you can afford each month and be sure to plan for emergencies when doing your budget.

  • Don’t believe what they tell you about re-financing or trading up. As the Times story details, these are often lies to pressure you into the purchase. If something doesn’t feel right to you, walk away.

  • Don’t expect them to work with you if you fall behind on payments. Their business model is heavily premised on repossessing cars in default and reselling them. So they aren’t going to be interested in working with you if you fall on hard times. They’re just going to repossess and sell the vehicle again. The Times story reports that many buy-here pay-here dealers outfit their vehicles with GPS devices and remote-controlled ignition blockers to allow for easy repossession. Those that don’t often resort to deceptive or very aggressive repossession tactics. In my experience, some of the most dangerous repossession encounters that I’ve heard about were ordered by buy-here pay-here lenders.

A vicious cycle in the used-car business | Los Angeles Times | October 30, 2011