Why Auto Loans From Car Dealers Are So Hard to Regulate

When we think about borrowing money, the first thing that comes to mind is how much: How much we need, how much it’ll cost, how much we’ll have to pay each month and how much time it’ll take to get out of debt.

Whether the money’s for a house, a car, college or for an unpaid credit card balance, these four financial variables—principal, interest rate, payment amount and term—are the fundamental building blocks for loans that are designed to be fully paid off by the time the last check is cashed. Typically, three of these four variables are used to calculate the fourth.

For example, suppose a borrower is approved for a $20,000 car loan. Also suppose that the lender wants that to be repaid in equal monthly installments over a period of four years, for which it charges a 5% annual rate of interest. The monthly payment amount calculates at just under $461 (lenders often use a present value calculator for this purpose).

Although the math is cut-and-dried, there is a fair amount of interplay among the four variables. For example, an increase in the interest rate will bump up the monthly payment amount, all other things held constant. But if the payment were to remain the same, that increased rate would either force a decrease in the loan amount (more interest charged on less dollars loaned) or cause the repayment duration to lengthen, provided, of course, the lender agrees to that.

The reciprocal relationship that exists among these four loan variables goes to the heart of a problem that Sen. Elizabeth Warren (D-Mass.) finds troubling.

The Issue… & How It Gets Complicated

The senator is worried about auto loans that are originated at car dealerships and the instances where the pricing for these are discriminatory against women and minorities, and those who lack the financial sophistication to know that they’re being unfairly treated. She wants these so-called indirect loans (indirect, because dealerships initiate the loans on behalf of the lenders with which they work) to be subject to the same oversight that governs consumer loans that are originated by regulated entities.

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Mitchell D. Weiss

Mitchell D. Weiss is a financial services industry executive and entrepreneur. He is also an Executive-in-Residence at the University of Hartford, co-founder of the university’s Center for Personal Financial Responsibility and adjunct faculty at Rutgers University. His most recent text, Practical Finance - A Straightforward Guide to Personal and Entrepreneurial Finance, is the basis for the course he teaches at both institutions.

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