Lenders have been required to disclose the cost of their loans — including interest rates and finance charges, expressed together as April — since the 1960s, when Congress passed the Truth in Lending Act.
But they can still exclude the cost of “credit-related” products such as car service contracts and gap insurance — which covers the difference between the amount you owe and what your insurance pays if the car is stolen or damaged — from the financing fee. Doing so results in a lower annual percentage rate (APR) than Illinois law calculates.
The new Illinois law is modeled on the federal military lending law, which Congress passed in 2006. The annual “all-in” law established an APR of 36 percent for loans taken by active-duty members.
But since anti-money laundering law doesn’t cover auto purchases, Illinois dealers were surprised to learn that the state’s 36 percent cap includes auto financing as well.
Although it’s unclear how many Illinois consumers might be protected under the new law, it’s easy to see how borrowers can benefit from it.
Suppose a consumer with a low credit score wants to buy a new Chevrolet Spark, and they find a dealer willing to let them finance it with a $17,000 loan. Terms include a $2,500 car service contract and a call to repay the loan over six years, with a monthly payment of $500 per month, which comes to an annual interest rate of approximately 29 percent.
But if the cost of the car service contract is converted into the financing fee, the annual interest rate jumps to more than 36 percent, bringing the total cost of the car and loan to $36,000.
Major lenders have also been accused of running against interest rate caps by charging fees on products such as loan amount gap insurance in lieu of finance charges. In Massachusetts, the state’s attorney general in recent years has filed complaints against auto lenders, including the Credit Acceptance Corporation, alleging financing loans that exceeded the state’s annual cap by charging for additional products in this way, according to documents reviewed by CR.
Credit Acceptance, which did not respond to a request for comment, moved to dismiss the claims in court, although the case is still pending.
A bill in Congress to be reintroduced would extend the 36 percent annual percentage cap under the Military Lending Act to include all Americans but not auto purchases. It should — depending on how you make such a change, says John van Aalst, an expert on auto lending at the National Center for Consumer Law.
“The devil is always in the details,” he says. “So, surely, you wouldn’t want such a cap that would prevent states from having a more effective cap.”
If a state wanted to have a cap of 20% or 25%, as some currently do, it “would not want federal law to prevent it from doing so,” he says.
In the meantime, if you’re shopping for a car, consider the total cost of the loan, not just the sticker price and monthly payment. Consider the annual interest rate, and also take into account the term of the loan. The longer the loan term, the more interest you’ll pay over time, and the longer the car stays upside down for less than the amount owed. Watch out for car purchase fees, too.
Find out how much you can afford and, if possible, consider getting a loan from a bank or other financial institution before heading to the merchant, who usually raise the interest rate for a profit.