American households have at least one car loan -- and more often than not, they've arranged that loan through a dealership after being promised "the best possible deal" on the interest.
But dealerships routinely mark up the cost of loans without telling the customer. It's a practice that would be illegal if you were financing a home, but not when you're financing a car. It's estimated that Americans are paying a billion dollars a year in undisclosed finance charges called dealer reserve.
If you don't know about it or ask about it, the salesmen and the finance managers certainly aren't going to tell you. Correspondent Steve Kroft reports.
Most people who walk into an automobile showroom know they are expected to drive a hard bargain with the salesman until they can finally agree on the price of a new or used car. And once they do, it's off to the finance office to fill out all the paperwork and arrange for a car loan.
"The typical consumer thinks that negotiations are over. …You have left the frying pan and you are headed for the fire," says attorney Jim Andrews, who has been after car dealers for years.
He says the finance office is where most customers get burned: "You think they're just helping a guy out in the showroom sell the car. You don't expect them to lie to you, and it's deceptive."
Dealerships don't actually make auto loans. They don't put up any money, and they don't have any risk. They simply arrange the loans through a finance company and promise the customers the best possible terms.
"What they tell consumers is that they're gonna give 'em the best interest rate they can get them," says Andrews. "And they find out what that rate is from the finance company, and then they throw in a few points for themselves."
Those few percentage points of interest that dealers add on for themselves - without telling the customer - is called "dealer reserve," and it can add thousands of dollars to the cost of buying a car.
The practice, which was an industry secret until a few years ago, has since produced a wave of litigation against some of the biggest names in the business such as GMAC, Ford Motor Credit, and Nissan Motors Acceptance.
Andrews brought suit against Covington Pike Toyota in Memphis, Tenn., and its corporate parent, the United Auto Group, a Fortune 500 company with annual sales of more than $8 billion. The class action accuses them of using deceptive sales practices on more than 12,000 Covington Pike Toyota customers, like Terry and Cheryl Traylor.
The Traylors were told that the best interest rate available to them was 19 percent. They also say they were led to believe that it was the finance company wouldn't go any lower based on their credit rating.
"I said, 'Wow. That's high,'" recalls Cheryl Traylor. "And he said, 'Yeah. Well, that's the best interest rate that we could get you.'"
In fact, the finance company, Toyota Motor Credit, had approved the Traylor's loan at 15 percent. It was the dealership that tacked on the additional 4 percentage points, adding $3,700 to the cost of buying the car.
The finance company, which was in on the arrangement, buried the additional interest in the Traylor's monthly payments, and then sent the dealership an upfront lump sum check for the difference. None of this appeared on the sales document, so the customers were none the wiser.
"The document says you're paying all that to Toyota Motor Credit. That's what the document says. Doesn't mention anything getting kicked back to Covington Pike Toyota," says Andrews. "It's a hidden charge. It's a kickback from the finance company to the dealership. And they never disclose it."
Andrews says that's not the only deception. Danny Ewing and Andrew Barbee are both former finance managers at Covington Pike Toyota. They ended up suing the dealership for racial discrimination, and are witnesses for the plaintiffs in the current litigation.
They've testified they were trained to persuade car buyers that they were their allies in trying to secure the best loan rate possible when their real goal was just the opposite. Most people don't know it, but finance managers are paid on commission and earn a big chunk of their paycheck secretly padding as much interest as they can get away with onto the back end of auto loans.
"You'd add a lot to it if you could," says Ewing.
Covington Pike Toyota and the United Auto Group insist that what they're doing isn't deceptive or illegal. Kent Ritchey is area manager for the United Auto Group, which owns Covington Pike Toyota and 137 other dealerships around the country.
"Dealer reserve is an accepted industry practice. I've been in the business for 34 years. I've never seen a dealership that didn't have dealer reserves," says Ritchey.
He adds that automobile dealerships provide a service by arranging auto loans – so they have a right to make a profit, and are under no legal obligation to disclose what he calls wholesale costs.
"If someone goes in to buy a hamburger, they're not aware of what the hamburger chain pays the franchiser, or they're not aware of what they paid the middle man to get the hamburger there," says Ritchey. "They're not aware of what the rancher makes. I think that they like the hamburger, they like the price … I think people understand all of the components of the transaction."
But the customer who is buying the car doesn't have to finance the deal through the dealership. They can go to a credit union or they can go to a bank and shop around.
"Absolutely. It's telling the customer that you're gonna get him the best available rate and not doing it. That's the essence of this lawsuit," says Andrews, who adds that salesmen and finance managers are advised to tell customers that they are given the best deal. "It's a written policy. It's in their training manual."
According to court transcripts, a United Auto Group training manual says "prospects will try and interrupt your presentation by asking questions about price, payments… interest rates, etc."
Memorize the following script: "I'm glad you brought that up. What I'd like to do is not only get you the best price available, but also find out about the down payment … and the best terms that are available."
So what does it mean then, when a car salesman tells you that he's going to get you the best possible deal in finance? "The best deal, the best rate, the best price, the best trade-in, is the best that you and the dealership can agree on," says Ritchey.
Will he be adding a few percentage points for himself? "Every component of the transaction is negotiated. Every deal is negotiated differently," says Ritchey. "Every individual has a different set of circumstances."
Ritchey says that most customers negotiate every aspect of the transaction, including the interest rate. But Ewing disagrees: "Most? Probably none of them."
As finance managers, Barbee and Ewing say it was part of their job to keep it that way. They've testified that they were trained to be as vague as possible when discussing financing terms with customers, to quote the payment and not the interest rate, and discourage them from reading documents.
"You wanted to get them to signing and you wanted to keep them going until you got to the contract and all the other stuff that actually had the numbers on them," says Ewing.
"Go ahead and sign this right here," adds Barbee. "Keep moving, keep moving, keep moving."
At Tennessee's Covington Pike Toyota, almost three out of four customers who arranged their loans through the dealership ended up paying dealer reserve. The average was around $800, but some paid much more.
"The only two services that the car dealer performs are, No. 1, to find a source of financing, and second of all, to take care of the paperwork. And for that, we think they're entitled to a fee, a reasonable fee. But not to a kickback that might exceed $1,000," says Steve Brobeck, president of the Consumer Federation of America, which is the largest consumer advocacy group in the United States.
In a recent report, the Consumer Federation of America cited a number of well-documented studies indicating that the people who paid the most in undisclosed interest charges to car dealers were those who could afford it the least. It also said that the practice took advantage of the least sophisticated buyers, especially Hispanics and African Americans.
"Car dealers size up the customer. And if the person is obviously well educated and is carrying a copy of Consumer Reports, they're not going to try to mark up that car loan rate," says Brobeck. "If, on the other hand, they're less affluent, they don't appear to be well educated and they're a minority, they may very well try to overcharge them."
"Those statements are absurd. They are absolutely ridiculous," says Ritchey. But that's not the way Barbee and Ewing remember it. They even had a name for that kind of customer: the less fortunates.
"To categorize the ideal customer that you want to get your hands on," says Ewing. "Those are the people that you made your living off of."
What was his idea of a perfect customer? "About a 40- to 50-year-old black person," says Ewing.
"Had the income. Had the money to afford it. But was kind of shaky on his credit and you've got that person. He's gonna make a big lick," adds Barbee. "We call it the big lick."
The lick was so big on Mildred Conley and her husband - nearly $7,000 - that Covington Pike Toyota made more money packing additional interest into their loan, than it did selling them the used Sequoia.
But even if the Conleys had known about the $7,000 in additional finance charges, they had a poor credit history, and they were at the mercy of the dealership.
That $7,000 in dealer reserve was due to a 4 percent markup. But lawsuits against the big finance companies have led them to try and rein in the dealers -- capping markups at 2 or 3 percent.
"Even one percentage point is really too much from our perspective," says Brobeck. "We have every reason to believe that there are some car dealers working with lenders who are charging in excess of 3 percentage points."
Car buyers, he says, should be told exactly how much the dealer is making on their loan.
"They do think that when they go to a car dealership and they ask the car dealership to find financing, that they're not going to be ripped off," says Brobeck. "There's no question that that's a rip-off.
Covington Pike Toyota and the United Auto Group say they've reached a tentative settlement of the lawsuit against them. The details are not yet public.
After the suit was filed, the dealership changed the paperwork that it gives to customers. There's now a clause that says they "may or may not receive income" arranging loans. The amount they make? That's still a secret.