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Auto Loans and Usury Laws: Protecting Consumers from Excessively High Interest RatesJun. 16, 2015 By Christopher Dalbey
UPDATE 7-30-2015: Attorneys in W&L’s Environmental and Consumer Protection Unit filed a class action lawsuit against Chrysler Capital for violating New York’s usury statute. The suit alleges that the dealerships are acting as agents for purposes of originating auto loans, making Chrysler Capital the real party in interest in the original finance contract. Therefore, the financing arrangement is a loan and subject to NY usury laws. If you are a victim of this usurious practice, please contact the firm. Read more about auto loans and usury laws below.
Aside from housing and food, automobiles are quite possibly the most important purchase that consumers make. Nearly 90 percent of the U.S. workforce commutes to work by car, and most car owners depend on auto loans to pay for the car they need to get there.
Car ownership affects where people can live and significantly expands job options; it is therefore a prerequisite to economic opportunity. According to the Center for Responsible Lending, “both the affordability and sustainability of auto financing are central concerns for most American families.”
Accordingly, vulnerable people with few options for auto financing — because of low incomes, poor credit, no credit history or other reasons — have essentially no bargaining power and are particularly susceptible to the whim and avarice of predatory lenders.
Interest Rates on Car Loans are Key
The interest rate is the key term in a loan because it largely determines the monthly payment amount and, subsequently, the car’s ultimate price. State usury laws regulate the maximum interest rate that lenders can charge to protect individual consumers and the broader community by regulating the amount of credit in the marketplace, lowering the default rate, and reducing economic hardship.
The maximum annual interest rates vary among the states. In New York and New Jersey, it is 16 percent; in Connecticut it is 12 percent. Although state usury laws have various exceptions (for example, nationally chartered banks are exempt), the dominant auto lenders are nonbank entities, including Ford Motor Credit, Chrysler Capital and Ally Financial. Therefore, usury laws should prevent auto lenders from abusing the most financially vulnerable among us.
Usury Laws Have Auto Loan Exceptions
In New York, the penalty for usury is severe. As applied to usurious auto loans, the lender must return all interest paid above the 16 percent legal rate, the borrower no longer has to make any payments, and, most importantly, the borrower gets to keep the car.
The billion-dollar auto finance industry, however, has long enjoyed two seeming exceptions to the usury laws. But these exceptions rest on fragile legal footing.
The first exception is that many courts recognize a distinction between loans of money and sales on credit. This distinction is important because usury laws typically apply only to loans or forbearances (agreeing to extend a loan deadline in exchange for interest).
The idea is that when a loan occurs, the borrower takes money in hand and agrees to pay it back later, with interest (i.e., money now for money later). But in a credit sale, the consumer obtains a product like a car and agrees to pay the purchase price over time, with interest (i.e., car now for money later).
The legal justification is that people are free to sell products at any price they choose and the price can be higher if payment is made over time instead of all at once. This is somewhat reasonable when the seller actually bears the risk of nonpayment, but auto sales operate differently.
In auto sales, a finance company typically approves the financing before the car is even sold, guaranteeing payment for the dealership. The dealership originates the financing by forwarding the prospective purchaser’s credit information to a finance company, or several of them. The dealership is a mere pass-through, and the finance companies dictate the loan terms.
Alternatively, consumers can apply for preapproval on finance companies’ websites before ever leaving home to go car shopping. Dealerships are under no obligation to secure the best deal for the purchaser and they often work to secure the best deal for themselves.
Many states, including New York, allow dealerships to secretly increase the interest rate to increase their profit. Finance companies usually limit this increase. Chrysler Capital, for example, allows a dealer to increase the rate by only 1.75 percent.
Usurious Interest Rates Charged by Auto Financing Companies
Even with these limitations, however, this system has led to discriminatory abuses by auto dealerships and finance companies that have charged a higher reserve to racial minorities. Indeed, Ally Financial recently settled a case under federal antidiscrimination law for $98 million.
To consummate the sale and financing transaction, the consumer and the dealership sign a “retail installment contract” under which the consumer owes monthly payments to the dealership, and the dealership immediately assigns this contract to the finance company.
This apparent two-step transaction is in substance an indirect loan. Instead of giving the purchase money directly to the buyer, the finance company gives the money to the dealership. The practical result is the same in this scenario as when a purchaser obtains a direct loan — the purchaser drives away with a car and must make monthly payments to pay off the loan.
One could argue that a direct loan is distinct because the proceeds could be used for any purpose. But, in reality, the direct lender would be likely to give the consumer a cashier’s check valid only to purchase a car.
When a finance company preapproves vehicle financing, guarantees payment to the dealership, and offers an interest rate above the legal limit, labeling the transaction as a credit sale is merely a smokescreen intended to conceal usurious loans. Thankfully, several courts have seen through the haze, including the Civil Court in Richmond and Kings Counties, New York and the Nebraska Supreme Court.
Car Sales Under Different Financing Rules
The second exception is that some states have different rules for automobile sales than for other types of sales. For example, under New York statute a “retail buyer” and “retail seller” of automobiles can “agree” to any finance charge (interest rate) that they please. But the N.Y. law protects only “retail sellers” of automobiles.
When the purchaser’s financing is preapproved by a finance company, the seller is merely a loan originator and the finance company is the real party in interest. Accordingly, N.Y. law should not protect finance companies that are obviously not retail sellers of automobiles.
For too long auto finance companies have structured their transactions with consumers and dealerships to conceal illegal, usurious loans. This abusive practice must be stopped for the benefit of individuals and the community at large.