After wrecking her car in a 1998 accident, Michelle Thompson urgently needed a new one to get to her job as a receptionist in Oakland’s City Hall. Her search took her to Fremont’s Autowest Honda, where she found a car she loved but signed an auto financing deal she came to regret. “My interest rate ended up being 17.95 percent, but I didn’t even pay attention to that,” she remembers. “I just needed a car.”
Thompson was paying more attention soon enough. Her payments for the used 1996 Honda Civic LX came to about $440 a month. “As time went on it became harder and harder to pay, and it still is,” she says. “It’s even more of a struggle now because I have a son.” By the end of this year, Thompson will have paid about $26,400 for a car whose “manufacturer-suggested starting price” for a new 2003 model is only $15,210.
Thompson felt ripped off, and suspected that her race played a role in the rate she was charged; she is black, and everyone who handled her financing that day at the dealership was white. Thompson, who now lives in Antioch, went on to join a trio of lawsuits filed jointly this April by four Bay Area law firms, which claim that African-American and Latino auto loan applicants are routinely charged more than white borrowers. The three class-action suits, each hinging on the experiences of at least one East Bay plaintiff, target American Honda Finance Corporation, Toyota Motor Credit Corporation, and WFS Financial, the lender that gave Thompson her loan. While Thompson’s 17.95 percent interest rate may seem like an exceptionally bad deal at a time that other borrowers were getting car loans for as little as 10 percent, the suits allege that minority borrowers typically pay between $500 and $1,000 more per loan than do white applicants of equal creditworthiness. This discrimination allegedly occurs as part of an eleventh-hour interest-rate “markup” imposed by the dealer with little or no relationship to the borrower’s finances or credit history.
The dealer markup works this way: If a buyer isn’t going to pay cash, or hasn’t previously arranged an auto loan through his or her own bank, the dealership runs a credit check that is used to calculate the interest rate on the buyer’s loan. This is based on a strict formula that takes into account the borrower’s income, credit history, and other economic factors. The dealership then submits the customer’s loan application to various finance companies, which, if he or she agrees to buy the loan, will specify the “buy rate,” or the interest rate they intend to charge. But the finance company’s offer is not necessarily the last word on the interest rate; the dealership is at liberty to mark up the interest rate however it chooses. “There is absolutely no business reason having to do with the riskiness of the loan or the cost of processing the loan,” says Oakland attorney Mike Baller, who is serving as co-counsel on the suits. “Those are already taken into consideration when the lender calculates the buy rate.” According to Baller, the dealership and the financing company typically split markup proceeds 75-25.
If customers aren’t aware of local interest rates and what their credit rating should be, they can easily be led into accepting these markups and paying a higher rate than they should, says Philip Reed, consumer advice editor for Edmunds.com, a consumer education Web site for auto buyers. People with less-than-perfect credit make particularly easy targets because they expect to pay higher rates, and Reed says some dealerships try to take advantage of this situation. “Once someone’s been bumped out of the first credit tier, the sales manager and the finance and insurance guy might say, ‘Let’s try to make a little profit on the financing, and instead of inflating this by two percent, let’s make it four,'” he says. “And if the customer complains, they say, ‘Oh yeah, we made a mistake.'” Every added percentage point adds about $500 to the price of a 60-month, $20,000 loan.
Since no mathematical formula governs the markup, Reed says dealers have a lot of “wiggle room.” The three Bay Area lawsuits allege that the size of the markup is based entirely on the subjective whims or prejudices of the dealer. And while there are many classes of customers who might seem ripe for ripping off — young or first-time buyers, for example — studies have repeatedly shown that when you control for all other variables, the standout factor is race.
The three lawsuits are heavily based on statistics gathered in preparation for a similar class-action suit brought in 2001 against Nissan Motor Acceptance Corporation. That study found that African-American borrowers were charged a markup 25 percent more often than whites, and that, on average, their markups were twice as large as those charged to whites. The study found consistent results in 33 states. Although it admitted no wrongdoing, Nissan settled the suit in February by agreeing to pay between $5,000 and $10,000 to each of the 125,000 plaintiffs, and donating another $1 milllion to consumer education.
On the other hand, the three finance companies named in the Bay Area suit are mostly keeping mum about how they will respond. Westcorp, the parent company of WFS Financial, did not return phone calls for this story. American Honda Finance Corporation confined its remarks to a brief press statement that concludes: “Honda does not and will not tolerate any conduct by its dealers that discriminates against customers or credit applicants on any basis.”
But Kerry Rivera, spokeswoman for Toyota Financial Services, cut right to the heart of what these companies may argue in court. “The dealer is their own business; we don’t have any control over what the dealership does,” she says. “We’re basically buying the contract from the dealer, and when we’re making our financing decisions we’re looking at a person’s credit and employment history. We don’t know the color of their skin.” In fact, all three respondents may press this point: if the high markup rates experienced by the Bay Area plaintiffs were all handed out at local dealerships, why file suit against these three auto loan lenders, all headquartered in Southern California?
The prosecution hopes to prove that charging Latino and African-American borrowers higher markup fees is an industry-wide practice and not just the work of a few bad-apple dealerships. During the discovery stage of the case, they predict, the financing disparities found in the Nissan case will be proven to also exist among the clients of American Honda Finance, Toyota Motor Credit, and WFS Financial.
Bill Lann Lee, an attorney with Lieff, Cabraser, Hiemann & Bernstein, the San Francisco law group that has taken the lead role in filing the suits, says the lenders should be held responsible because they reap the financial benefits of the markup system. After a home, cars are generally the second-priciest purchase most people make, and lenders have made hundreds of millions of dollars off all those extra $500 markups. This drains money not just from the bank accounts of customers, but from entire minority communities. He points out that recent high-profile suits have been fought over similar practices in the mortgage lending and banking industries; the twist is to apply the same standards to auto loan lending. “These are kind of cutting-edge civil rights issues,” says Lee, who served as assistant attorney general for civil rights during the second half of the Clinton administration.
Lee, Baller, and their colleagues will argue that even if financing companies don’t intentionally discriminate, they are still culpable because they participate in a system which has a disproportionate adverse effect on minority consumers. More to the point, they say, the companies should be aware of this, because in addition to the Nissan study, a host of private and government reports have made the same point. According to California law, intent to discriminate can be inferred if a company should have known that its policies produced a discriminatory effect, yet did not take steps to correct their practices. “When they said, ‘Let’s go ahead and continue to do it anyway,’ that is a form of discriminatory action, even if they are not the people carrying out the discrimination on a retail level,” Baller says.
Lenders aren’t entirely unaware of how dealers inflate loan rates — Toyota’s Rivera, for example, cites a company policy that went into effect last year forbidding it from buying financing contracts if the dealer intends to charge the buyer more than three interest points higher than what Toyota offered. But Rivera also emphasizes that buyers who believe they are being quoted an unfair rate have a right to negotiate for a better one. Reed agrees that this is true, but points out that many buyers don’t haggle at the dealership because they’re afraid of losing the car. “Most consumers don’t realize they’re actually in a very strong position because the market’s competitive,” Reed says. “But they’ve got you captured. The car is there and ready to go. Most people come out thinking, ‘Well, I paid a little more than I wanted, but I really wanted the car. ‘”
And finally, lack of familiarity with the murky financing process is one of several factors that affect the interest rate they’re offered. Certainly in Thompson’s case, factors other than race may have contributed to her 18 percent interest rate: her inexperience as an auto buyer and desperation to get a new car, the fact that she hadn’t done much shopping around beforehand, her acknowledgment that her credit was only “okay.” Other factors also probably affect a buyer’s treatment, including their age, gender, and aggressiveness as a negotiator. But there’s a bottom line, Baller says: “There may be different reasons why people get ripped off, but race is not a permissible reason. The law doesn’t require African Americans or Latinos to be better negotiators or better prepared than white borrowers to get a fair loan.”
While the three class-action suits won’t be argued in court anytime soon, they may get some new companions. Both Baller and Lee say that the firms are investigating Mitsubishi, and that similar suits may be filed against other auto financers as well. As for Michelle Thompson, she says she joined the suit to make sure that what happened to her never happens to anyone again. And although Lee admits that any financial restitution made to Thompson and the other plaintiffs would probably be small, if they win, the lawsuits could play an important role in stamping out a form of discrimination that seems shadowy and diffuse, yet still produces a pattern of very concrete hardships for minority auto loan recipients. “Justice Sandra O’Connor said that when you’re dealing with discrimination, sometimes you’re dealing with things that can be subtle,” Lee says. “It’s been a long time since we had black and white water fountains and segregated schools, but courts have found that practices that aren’t as rigid are also problematic.”
The Loan Matters
You’re not done negotiating once you’ve priced the car.
Buying a car and worried about paying inflated markup charges on the loan? Philip Reed, consumer advice editor for Edmunds.com, suggests the following:
* You’ll have more flexibility to negotiate on the terms of your loan if you call ahead to get price quotes on cars from several dealers.
* Get a credit check beforehand and, if possible, correct any blemishes you may have been unaware of, such as unpaid credit card bills.
* Know the going rates for auto loans in your area as well as your own credit rating. Edmunds.com offers free online estimates of both.
* Check to see if any financing incentives are being offered.
* Consider getting a preapproved auto loan.