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Trading Rate for Product (and Why It’s a Very Bad Idea)

Offering lower interest rates to boost sales of F&I products is a legal minefield few dealerships are equipped to navigate.
By: Jim Ganther

Trading Rate for Product (and Why It’s a Very Bad Idea)

Your company may design excellent and appealing coverages, properly price and reserve, and perform exquisite claim administration. But at the end of the day, none of that matters if the F&I manager facing the customer can’t make the sale. Frustrating, huh?

To help F&I managers get over the hump and make the sale, providers and administrators offer onsite or home office training, technology tools such as menus and desking software, and advice. It is everyone’s interest that any advice given is actually legal. Sometimes that’s tricky.

The Nuisance Is in the Nuances

The reason lawyers can cost so much is their training and experience with “Depends.” No, I don’t mean the adult diaper (though there may be some overlap). Rather, whether something is legal or not depends on many different variables, not all of which are obvious. So even if an F&I manager knows a basic legal principle, the nuances can get him in trouble.

Case in point: I was recently asked by a TPA employee (responsible for keeping their representatives in the field out of trouble) if it was OK for a dealer to “trade rate for product.” Trading rate for product means offering a customer a lower interest rate if the customer will agree to purchase an F&I product, such as a vehicle service contract. The general legal principle is freedom of contract, right? Except in certain states (I’m looking at you, Florida), the retail cost of F&I products is not regulated, so dealerships may negotiate their price. APR is negotiable, too. So trading rate for product should be perfectly fine.

And it is … except when it’s not.

Here’s one variable to consider: does the product price become a finance charge? This is a very, very big issue, and the leading reason I don’t recommend dealers trade rate for product. The Truth in Lending Act (TILA) defines “finance charge” as “the sum of all charges, payable directly or indirectly by the person to whom the credit is extended, and imposed directly or indirectly by the creditor as an incident to the extension of credit. The finance charge does not include charges of a type payable in a comparable cash transaction.”

So let’s say a customer has been offered an APR of 4.5% on his financing and the dealer offers to drop the APR to 4.0% if the customer buys a $2,000 service contract. This could be a method of “hiding” rate within the cost of the VSC. In Florida, where there is a presumption every customer pays the same amount for the same VSC, this might not be a problem. Everywhere else, it might be. Say the finance customer pays $2,000 for the VSC that drops his APR, but a cash customer paid $1,500. A court could easily find that the $500 difference was, in fact, a finance charge.

“So what?” you ask. Here’s what: All finance charges must be accurately and conspicuously disclosed in the “TILA box” on the Retail Installment Sale Contract. If part of the finance charge is buried in the cost of the VSC, the disclosures in the TILA box will be inaccurate and misleading.

“So what?” you ask again. Here’s what, again: If the violation was (1) intentional, (2) grossly negligent or (3) part of a clear pattern, all affected customers are entitled to restitution. In most dealerships that trade rate for product on a daily basis, both factors (1) and (3) will be present. That is not good for the dealership. And it only goes downhill from there.

Regulatory fines are the least of the dealership’s worries. Because trading rate for product is often a standard sales tactic at the dealerships who indulge the practice, it now sets up a class action. And since it is a violation of federal law to understate APR or finance charge, punitive damages enter the picture.

The CFPB’s Mandate

But wait, there’s more. Remember the Consumer Financial Protection Bureau? When a dealership reduces the rate for customers that buy a product, it triggers a deviation from its standard dealer participation rate. The CFPB recognizes seven legitimate nondiscriminatory reasons for deviating from the standard rate. Purchasing an F&I product is not one of them. (If the dealership does not have a fair credit policy and program such as NADA offers, it has a whole other set of problems that we’ll address in a future article.)

And we’re not done yet — not by a long shot. If a dealership routinely trades rate for product, can it prove the initial APR was not artificially inflated to make room for the “discount”? This requires an analysis of the desking process and timing of when a credit report is pulled. In short, any dealership trading rate for product had better have a bulletproof and consistent desking process that can demonstrate the APR is appropriate for the customer’s credit risk, and has a consistent mark-up, like the standard dealer participation rate discussed above.

On top of that, to protect the process of trading rate for product, there should be a standard markup on products as well. If the profit margins on products are all over the board from deal to deal, proving a legally compliant deal is difficult at best.

And another thing: When a deal jacket is audited, one of the things auditors look for is variation in APR and amount financed from the first pencil to the menu to the buyer’s order and RISC. Any variation requires an explanation. Is there a process in place to memorialize the negotiations and create a clear paper trail?

Think this is confusing? Imagine how confusing it could be for the customer. And in the eyes of the FTC, if it’s confusing, it’s deceptive. Another potential whammy.

Does the dealer trade rate for product more often with women and minorities than white dorks in bow ties? Add potential discrimination to your list of worries.

Going back to the original question, is it OK to trade rate for product? Of course it is — as long as you dodge all of the landmines that come with the practice. Do you trust your client dealerships’ personnel to consistently do so? Neither do I. And that’s why I never recommend it.

This article was written by:

- has written 15 posts on P&A Magazine.

Jim Ganther is president of Mosaic Compliance Services. He is an attorney and a member of the National Association of Dealer Counsel.

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The views expressed by the authors and those providing comments are theirs alone, and do not necessarily reflect the views of P&A Magazine or any employee thereof.

One Response to “Trading Rate for Product (and Why It’s a Very Bad Idea)”

  1. Marv Eleazer says:

    Improperly handled and documented, this practice could create major headaches for a dealer.

    Obviously, the deal starts at the desk in most stores when a manager makes the first offer with an estimated rate and those negotiations in paper format are usually left in the deal jacket as part of a permanent record of the deal.

    This creates a paper trail as easy to follow as the Yellow Brick Road and an F&I manager better have a good reason by documenting it.

    If an F&I producer offers a rate reduction as an inducement to a customer in exchange for a lower APR, he has dumped all of Pandora’s box on the floor.

    Can this be done legitimately? In my opinion it can be if handled properly. Since dealerships are the initial creditors, they set the finance rate however, the Federales have the last say from an ethical point.

    Unfair and Deceptive Acts and Practices (UDAP) protects customers from underhanded miscreants.

    Our’s is a monthly payment economy and as such, customers are always concerned about how to budget for such things as car payments. That sensitivity isn’t lost in the F&I office which is why some finance managers engage in the practice.

    It seems proper to me to offer the customer a lower payment by reducing the rate in order to make the product more affordable on a monthly basis.

    But……………..once that happens and the customer still declines then raising that rate back up would be a clear violation and should be avoided at all cost.

    Again, paper trails are easy to follow and this should be something notated on a Dealer Participation Certification Form found in DealerTrack and RouteOne if the rate changes from the desk manager’s offer to F&I.

    Great subject matter and well written, Sir James.

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