Auto Loans: 
Car Dealer Reserve -- Kickbacks and Markups -- Hidden Finance Charges

With one in three American households paying on an auto loan at any given time, the opportunity for fraud is tremendous among auto financers and car dealerships. Most car buyers who finance aren't aware of what is going on behind the scenes, which is that car dealerships rake in more than $1 billion in extra profit each year from what is known as dealer reserve.  One in four car buyers needing financing are targeted for this scam, with the majority of victims being Hispanic or African American car buyers.

Dealer reserve is a kickback paid to car dealerships by the finance companies (including those owned by car manufacturers) for bringing in new customers.  Dealer reserve can be defined as interest points that usually constitute two to four interest points added to the interest rate, and can tack on thousands to the price of a car and increase one's monthly payments by $30, $50 or more.  This is basically how it works:  The car manufacturer, say Ford Credit, offers to finance someone's new car purchase for 15%, but the car dealer doesn't tell the customer that.  Instead, they tell him that the lowest interest rate he qualifies for is 19%.    Ford Credit sends the check equal to the 4% markup to the dealership as a commission.  The customer gets to pay off the 4% dealer reserve without realizing he actually qualified for a 15% rate!

Is this practice legal?  Yes, it is legal.  There is not a law against keeping hidden finance charges hidden when it comes to auto financing.  After all, car dealers make the argument that their finance managers have the right to earn a commission on helping customers obtain financing, and the average dealer reserve adds $850 to the price of a car.   Who is more likely to pay dealer reserve -- members of minority groups and those with low incomes, whom the auto industry calls the "less fortunates".  Be aware that if you are African-American, Hispanic, female, or have a modest income, you are at a higher risk of being targeted for this scam, but white males can be victims too.

The good news is that there are ways to avoid dealer reserve.   The easiest way is to obtain financing on your own before you go car shopping.  Become a member of a company or community credit union and establish a relationship with them by opening checking and savings accounts so when the time comes that you need financing, you can qualify for the lowest rates available for someone with your credit score. Another way to obtain financing might be to go online.  Companies like and base their credit decisions on your credit score and nothing more. 
Another way to avoid having your interest rate marked up is to inform the car dealership that you are aware of the practice and are not going to tolerate it happening to you.  Therefore, if you must obtain financing through the car dealership, ask specifically about dealer reserve.  "How much are you taking as a kickback from Toyota?" or "Are you marking up my interest rate?"  Let them know that you are aware of this practice and insist that they not inflate your interest rate. 

Note that consumers are fighting back.  At least twelve class action lawsuits have been filed against finance companies owned by the major car manufacturers.  In the past, both General Motors and Nissan settled class action lawsuits against them, agreeing to limit the amount of markup and inform consumers that they can negotiate for a lower interest rate.

Of course, make sure that you do everything possible to raise your credit score.  The higher your credit score, the lower the interest rate you will be charged.  Know what your FICO credit score is before you go shopping for financing and research car loan rates for those with excellent and poor credit.  If your credit score is above 750, you should be offered a lower rate.  If your credit score is below 700, you will pay a higher interest rate if you don't improve your credit beforehand.
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