Understanding Auto Finance Rules and Regulations

A recent Interagency Fair Lending Webinar that took place in December 2022 discussed some specific issues regarding discrimination in auto finance. Rules and regulations regarding potentially unfair lending practices were identified by the Federal Deposit Insurance Corporation (FDIC), who ultimately referred these potential violations to the Department of Justice (DOJ) for enforcement. One specific area the webinar looked at dealt with pricing auto contracts made indirectly via dealerships. The FDIC saw cases where banks left the pricing of these retail contracts to dealers, a common practice, that then led to borrowers receiving loan terms that were priced differently. In these cases investigated by the FDIC, there was evidence that dealers used their discretion to price differently according to a borrower’s sex, national origin, disability, or other prohibited bases.

Lenders must pay particular attention to how the FDIC identified this issue to maintain compliance. Using statistical modeling, FDIC economists evaluated whether differences in loan pricing were statistically significant and whether these differences were made on a prohibited basis. They analyzed the allowable markup and rate at which the bank purchases contracts from dealers, from which the contract rates are then determined. When the FDIC found these referred cases were indeed statistically significant, it concluded the differences in loan pricing were likely not due to chance. In doing so, the FDIC linked dealer discretion to higher rates charged to borrowers on a prohibited basis.

This is a warning to auto lenders who buy dealership contracts. Even if they follow auto finance rules and regulations to the letter, lenders can still be deemed non-compliant in their lending practices. If this sounds familiar to some lenders, it’s because the Consumer Financial Protection Bureau (CFPB) previously issued similar guidance. In 2013, certain dealer markups that resulted in higher interest rates for protected classes could be deemed illegal under the Equal Credit Opportunity Act. Though Congress overturned this guidance in 2018 for the CFPB, it has yet to be disapproved by the FDIC, while certain states have also passed legislation that enforces similar rules or regulations. To keep from falling foul of regulatory agencies, lenders should utilize solutions that make auto finance rules and regulations easier to follow.

Many lenders are turning to technology to help them maintain regulatory compliance. While digital technology has made its way into nearly every industry, its capabilities offer significant benefits for both lenders and their customers. As economists at the FDIC used statistical modeling to uncover discriminatory practices, lenders can also use technology to analyze data to ensure that they remain compliant with any new auto finance rules and regulations.

When it comes to auto finance, rules and regulations in the United States emanate primarily from federal or state authorities. Those at the federal level are the basis for legal authority throughout the country. This means that rules and regulations for leases and loans at the state level must be at least as stringent, or more so, than those at the federal level. For example, if a federal regulation limits interest rates on an auto loan for a subprime borrower at the federal level, the rate of the loan can’t be set above this rate. However, a state statute could set a rate below this federal rate.

Rules and regulations aren’t laws themselves but rather directives that explain how to implement these laws. Regulations are more formal than rules, though they both prescribe exactly how auto lenders must conduct themselves, along with actions agencies tasked with enforcement can take if they don’t. Though rules are binding, they also describe how lenders should conduct themselves during the entirety of the leasing or lending process. Essentially, agencies use rules in the application, enforcement, implementation, and interpretation of laws or court decisions.

In the United States, legislation is written by a legislative body, whereas rules and regulations are the purviews of the executive branch, which enforces legislation. For a lender involved in auto finance, rules and regulations place limits on how they can go about providing their customers with leases or loans. In practice, this makes national agencies like the CFPB, FTC, and FDIC, along with state regulatory agencies, the enforcers of the laws that legislative bodies like the US Congress or state legislatures pass.  

Federal agencies who make and enforce auto finance rules and regulations include:

• Consumer Financial Protection Bureau (CFPB): Makes sure banks, credit unions, and other lenders treat their customers equitably by implementing and enforcing federal laws that seek to maintain transparent and evenhanded treatment of consumers while also maintaining fairness in the market competition between lease and loan providers. 
• Federal Trade Commission (FTC): Tasked with enforcing federal laws to protect consumers, the FTC helps prevent deceptive and unfair leasing or lending practices, enforcing antitrust laws that lead to higher prices or fewer choices for consumers, along with stunting innovation.
• Federal Deposit Insurance Corporation (FDIC): Investigates consumer complaints against banks, credit unions, and other lenders, along with responding to inquiries concerning rules and regulations meant to protect consumers.

CFPB

The CFPB starts with research to guide its rulemaking process while also listening to the public through various advisory bodies, hearings, roundtable discussions, and business review panels. After assessing the costs and benefits of proposed auto finance rules and regulations, the agency usually publishes these rules before they go into effect to give stakeholders the opportunity to comment on possible effects. The CFPB also helps those affected comprehend and comply with rules and regulations once they’re in place by providing resources and other support.

FTC

When it comes to auto finance, rules and regulations enforced by the FTC focus on those which do the greatest harm to consumers. They investigate claims concerning unfair or deceptive actions or procedures that affect commerce, as well as practices that promote unfair competition. They seek to prevent these in order to protect consumers and competition in the auto financing market. Rules and regulations are enforced by the agency through injunctions and restitution, though sometimes civil penalties are also incurred against lenders.

The agency seeks to prevent deceptive and unfair lending practices in the auto finance industry by uncovering and preventing fraud. It administers over 70 laws, including the Fair Credit Reporting Act, Federal Trade Commission Act, and Identity Theft Act. The FTC additionally publishes reports and makes recommendations to Congress, regularly reviewing rules and guidelines to ensure they’re effective and not too burdensome, eliminating and modifying rules to keep them current with the constantly changing auto finance markets.

FDIC

The Federal Deposit Insurance Act governs FDIC rules and regulations regarding auto finance. The agency oversees banks and other financial institutions that it insures through this act, providing them with guidance about how to comply with the relevant laws for auto finance. Rules and regulations regarding the auto financing industry seek to protect consumers while ensuring the lenders with whom they do business are sound.

As the primary regulator of banks at the federal level, they examine whether lenders comply with consumer protection laws like the Truth in Lending Act, Fair Credit Billing Act, the Fair Credit Reporting Act, and the Fair Debt Collection Practices Act. The agency also investigates complaints at the institutions it supervises, helping to facilitate the resolution of disputes between lenders and borrowers when necessary.

State Regulations

As federal regulating agencies have retreated in recent years, state regulators have begun to oversee financial institutions involved in auto finance. Rules and regulations presented by a coalition of attorneys general in over a dozen states and the District of Columbia seek to fill the void left by federal regulators. These have included both affirmations of intent to oversee auto lenders, as well as identifying new federal policies that could harm auto leasing or lending business in certain states.

Before implementing measures to maintain compliance, lenders should engage legal counsel in order to understand the key federal and state laws that cover auto finance. Rules and regulations concerning these laws standardizing vehicle leasing and lending practices are meant to protect consumers, but scrupulous lenders benefit from these as well, and it’s essential that lenders know which regulations affect their business. By ensuring all decisions concerning vehicular leases or loans are made fairly, lenders protect themselves from civil lawsuits for unfair business practices.

Key auto finance rules and regulations at the federal level include:

• Consumer Leasing Act: This legislation requires that lessors disclose certain information before the customer signs a lease or delivers the vehicle. This includes payment amounts, the number of payments to be made, licensing and other fees, any taxes due, charges for late payments or defaults, purchase options, the price of the purchase at lease end, and any additional payments that must be made before the end of the lease. Additionally, lessors need to disclose any charges for excessive mileage and the number of miles lessees are allowed to drive annually.
• Credit Practices Rule: This requires that lenders provide written notice about liability to any potential cosigners of a loan, prohibits late fees in certain situations, and prevents lenders from using certain provisions in contracts that have already been deemed unfair to consumers.
• Equal Credit Opportunity Act: This prohibits discriminatory lending practices due to age, gender, marital status, national origin, race, or religion. It also prevents lenders from discriminating against borrowers receiving public assistance or having exercised their rights under the Consumer Credit Protection Act. For certain lenders, it also means they must provide reasoning behind loan denials or other adverse actions.
• Fair Credit Reporting Act: This legislation provides consumers the right to obtain a free credit report from each one of the three nationwide agencies that create credit reports for consumers. The act enables consumers to dispute any information in their credit reports if they believe it’s incomplete or inaccurate while also allowing consumers to report identity theft via a single phone number to all three agencies. Another requirement is that when lenders deny loans or take other adverse actions, they must provide loan applicants with their credit scores and reports if they were used in the process. 
• Risk-Based Pricing Rule: Whenever consumers apply for an auto loan, this rule ensures that applicants receive information about their credit scores, often through a Credit Score Disclosure Notice. These notices not only list applicants’ credit scores but also put them in context and how they compare to other consumers.
• Servicemembers Civil Relief Act: Protecting active military against auto repossessions entitles military members to loans at interest rates under 6 percent while allowing them to terminate existing vehicle leases when deployed for over 180 days without penalty.
• Truth in Lending Act: Before a customer signs an agreement, lenders must disclose certain loan terms, such as annual percentage rate (APR), amounts of monthly payments, dates when payments are due, the total amount and length of the loan, along with any fees that will be charged for late payments.

Given the perception that federal courts have limited federal agencies tasked with overseeing auto finance, rules and regulations passed by state regulators are likely to become increasingly important to lenders in the near future. State legislatures are particularly looking at legislation that protects consumer data and deals with guaranteed asset protection (GAP) waivers.

It’s important for auto lenders to keep up with any new rules and regulations for vehicle financing, along with those that are soon to be enacted or even those just being discussed. New state legislation concerning data protection and cybersecurity is coming into effect in California, Colorado, Connecticut, Utah, and Virginia throughout 2023. It’s likely more states will follow this trend, so lenders would do well to ensure their policies and procedures concerning the protection of customer information comply with these new statutes and any future ones.

In California, legislation on GAP waivers comes into effect in January 2023. GAP protection allows a borrower to forgo payment of any balance due a lender when a vehicle is wrecked beyond repair or if it’s stolen. Lenders like these services because it ensures they’ll get paid out in the event a customer suffers such a loss, but this California bill places restrictions on this and other types of optional coverage. The law makes GAP waivers non-compulsory, stating that no optional coverage can be required in order to get loan approval or specific loan terms. As California is a leader in state legislation concerning auto finance, it’s probable that other states will pursue similar legislation.

New Federal Legislation

Though action on data protection and privacy was expected this year, no new legislation concerning regulations at the federal level has passed. Additionally, with the change in leadership in the US House of Representatives, it’s not likely federal legislation concerning consumer data privacy will become law anytime soon.

Federal Enforcement

On the federal level, auto finance rules and regulations by the CFPB look to be focusing on policies and practices concerning repossession and debt collection. The guidance regarding repossessions is similar to what the agency put out in 2018, but there looks to be little change. This places an additional burden on lenders to properly manage vendors and ensure internal systems are robust enough, while the agency also encourages lenders to document consumer agreements on payment plans thoroughly.

Additionally, the CFPB’s very existence is being questioned by an October 2022 decision by the Fifth Circuit Court of Appeals. In Community Financial Services Association v. CFPB, the agency’s self-funding mechanism was declared unconstitutional, though it looks like it will also be resolved in the new year. This essentially invalidates federal restrictions against lenders who offer short-term loans at high interest rates.

Meanwhile, like California, the FTC is showing interest in practices related to protection products like GAP waivers. The agency is currently proposing a rule that bans bait-and-switch advertising tactics and junk fees, which hamper a consumer’s ability to comparatively shop and can cost thousands in unwanted fees. With this rule in place, both honest dealers and consumers will be protected while also making the auto lending process more competitive.

The new FTC auto finance rules and regulations ban:

• Bait-and-switch claims: This prevents dealers from luring prospective buyers with deceptive claims in their advertising. This deception could include vehicle cost, rebates or discounts, loan terms, cost of add-on products, and availability of the advertised vehicle. 
• Fraudulent junk fees: This forbids dealers from charging for any fraudulent add-on services and products that don’t benefit consumers, such as offering nitrogen-filled tires containing the same amount of nitrogen as the air outside the tires.
• Surprise junk fees: This bars dealers from making customers pay any added fees without written consent while also requiring that they provide information on prices without adding optional services or products.

Additionally, this FTC proposal requires that key disclosures are made to consumers about vehicle costs and loan conditions. This includes dealers providing their customers the real offering prices for vehicles, essentially the total price being paid for the vehicle without required governmental fees and taxes. This proposed rule change also necessitates disclosure of any optional fees for added products or services, along with ensuring they won’t affect the lease or loan conditions and the terms of any loan offered.

While this doesn’t directly affect lenders involved in vehicle finance, rules and regulations concerning dealerships that try to subvert such legislation can cost lenders dearly. If a dishonest dealer is caught, recovering the money lent to a borrower defrauded by a dealer with whom a lender does business becomes even more difficult. For this reason, lenders need to ensure that rules and regulations for auto financing are followed meticulously by everyone with whom they do business. This is where technology can help.

With ever-changing auto finance rules and regulations, along with continuously evolving legislation, it’s difficult for lenders to maintain compliance. Specific technologies now allow auto lenders to make fairer decisions, better protect consumer data, provide digital documentation and prevent fraud. All of this also helps ensure lenders maintain compliance with current auto finance rules and regulations. By adopting cutting-edge lending systems that incorporate analytical tools, automation, and the digitization of documents, lenders can make themselves more transparent.

Compliance at the Point of Loan Origination

With the limits placed by courts in recent years on federal agencies, it’s very probable that state regulators will step up enforcement of legislation affecting auto finance. Rules and regulations first affect consumers during the application process. To make this process fairer and compliance easier, lenders should adopt an automated loan origination system (LOS), which allows lenders to better comply with relevant rules and regulations. Auto finance companies can then eliminate much of the variability that often occurs when origination processes are done manually.

Advantages of a modern cloud-based LOS that help auto lenders comply include:

• Allows tracking which, when, where, and for whom decision rules are altered should an audit occur.
• Can create and implement new decision rules without the need for coding or other technical experience.
• Easy to modify decision rules to mirror changes in federal or state auto finance rules and regulations.
• Negates the need of human stakeholders like underwriters or servicing agents to remember specifics concerning complying with specific rules or regulations.

These capabilities are much more expensive and time-consuming with an older legacy system or LOS that requires third-party developers to alter how a lease or loan is underwritten. The latest LOS helps overcome these barriers that previously made compliance so difficult. Not only does it make inputting new decision rules easier, but it also provides auto lenders with a way to better evaluate and take action on data collected during the application process.