Imperfect Competition in Auto Lending: Subjective Markup, Racial Disparity, and Class Action Litigation

While the market for auto lending at first appears to be highly competitive, many consumers lack the ability to obtain accurate information about price. In many markets, uninformed consumers can “free ride” off the knowledge of informed consumers. Auto lending, however, differs from traditional markets because price is not transparent and ultimately depends upon both the credit worthiness of the individual borrower and the details of the auto loan (term length, payment-to-income ratio, etc.). Auto dealers in this market act as agents of both consumers (identifying suitable auto lenders) and lenders (identifying prospective borrowers). Given the asymmetric information in the market, prices paid by consumers for auto loans vary widely even after controlling for factors such as credit worthiness. While the majority of auto loans are written without any markup, some consumers are charged thousands of dollars in addition to the risk-based interest rate. For example, the top 5% of customers account for over 40% of dealer markup from auto lending. While charging different prices to different consumers is not illegal, one of the apparent consequences in auto lending is that minority consumers – African-Americans and Hispanics in particular – have systematically been charged a higher markup on auto loans than White borrowers. It is this fact – coupled with federal laws outlawing discrimination in credit markets – that led to a series of lawsuits against auto lending institutions. This paper reviews the theory and evidence of subjective markups on auto loans and examines how class action litigation has changed the auto lending market.