Have you wondered why industry publications are writing with increasing frequency about the expected demise of finance “markup”? The answer is simple – proponents of flat fees are working to sell the concept that “markups” are evil to regulators like the federal Consumer Financial Protection Bureau and the Federal Trade Commission with the hope that they will take action. So what effect would a flat fee requirement have? Like any mandated change in the way an entire industry operates, it is hard to predict the impact clearly. But that is the problem. No one knows the ultimate outcome, and bad results with real damage to the car business are likely.
To begin, “markup” is actually an incorrect and derogatory label based on the false assumption that the wholesale rates available to dealers because of their relationships with finance sources are available to consumers without the work of dealer personnel. We are really discussing dealer reserve, which is a phrase that derives from the early practice of finance sources to deposit dealer profit on financing into an account to be released as loans were paid off. Today’s payments to dealers on financing are simply advances against those reserve accounts.
So what are the risks from elimination of the reserve system?
- The present system incentivizes F&I representatives to fight for the lowest wholesale rate qualification for a customer so that the quoted dealer rate will be more favorable. A flat fee is just that – it is a fixed amount paid regardless of the rate paid by the customer, and it may reduce the incentive to fight for the lowest wholesale rate leading to higher finance rates with a negative impact on sales.
- Reduced incentives to work to qualify a customer for financing could actually make it harder for credit-challenged buyers to purchase a car. That negatively affects not only those buyers, but dealers, manufacturers, and finance sources.
- The case against “markup” is built on the false premise that dealers act like home loan brokers who bear much of the blame for the recent financial meltdown. But a home loan broker works to sell the loan itself. Once that loan is assigned to a lender, the broker walks away with no further responsibilities. Dealers sell cars and trucks, and they offer financing to facilitate those sales. Dealers are accountable for how they sell and finance vehicles for years after the transactions, so they are nothing like home loan brokers. Ironically, however, flat fees that may make it easier to sell car financing over the phone or online could lead to the type of finance brokering that was so detrimental to the mortgage market.
But what about discrimination and other problems consumer advocates have complained about for years? Like other parades of horribles offered by dealer detractors, the problems of the reserve system are anecdotal and based on outdated information no longer accurate because of finance source limits and improved desking and selling practices.
If a change to the system is so potentially problematic, won’t finance providers and others defend the system? Don’t expect that.
- Finance sources can live with flat fees because they may make compliance with non-discrimination testing easier, and finance sources like the ability to set customer rates.
- Manufacturers may seek to protect their captives who have the same interests as other finance sources.
- Online companies, particularly portals, may see flat fees as making it easier to sell finance and ancillary products online, and that is to their benefit.
That leaves dealers themselves as the ones who must speak for the present system. Your national and state dealer associations are telling the story of why today’s finance system works. They need your support. If you are asked to appear at an event or you have the chance to speak to a legislator or to an opinion maker such as a reporter or a member of the editorial board member of your local paper to explain why the reserve system leads to lower rates for customers and increased sales to the benefit of dealers, manufacturers, and finance sources, take the opportunity.
Also, if called upon to show that your F&I reserve practices are legal, fair, and non-discriminatory, how would your dealership do? A sound system includes a number of safeguards.
- A desking policy in which managers controlling deals understand the rates available to customers and quote available rates.
- A policy of target rates with upward and downward departures permitted for competitive and non-discriminatory purposes.
- A practice of selling the vehicle before referring the customer to F&I to reduce the temptation to manipulate rates to make a sale.
- Worksheets that have been reviewed by counsel and that accurately describe the terms of deals to your customers.
A government mandated change to the way an entire industry does business will have effects that no one can anticipate. With the huge potential for negative fallout from the imposition of flat fees, that is too big a chance to take with the entire retail car business at stake.