The Truth-in-Lending Act is your friend

Credit is the right to put off paying for something you get now.  Credit almost always costs money.  When you buy a car or a living room set in installment payments, you pay more than if you bought it for cash.  If you take out a loan — whether from a bank or a pawnshop — you have to pay back more than you borrowed.   But how much more?

One element of the cost of credit is interest, expressed as an interest rate.

In olden times, laws limited the interest rates that various kinds of lenders could charge.  Charging excessive interest is called usury.  Many religious traditions still consider usury to be immoral, especially when directed at poor people.  But over the past generation, as “deregulation” became national policy, laws against usury eroded.   Nowadays, in most loans and sales there are no limits on  interest rates and other charges!  Where there are legal limits, such as in the sale of used cars, they are high.  This puts the burden on us, as users of credit, to know the cost before we sign on the line.

Credit is a service that’s bought and sold.  You can shop for it, just as you shop for the best price on other goods and services.   The costs of credit varies depending on who is lending the money and also depending on your credit score.  But it can be hard to compare different offers of credit.  One car loan might be for 4 years, another for 6 years.   Repayment intervals might be every week, every two weeks, or every month.  In addition to interest, there may be application fees, acquisition fees, and other kinds of fees.   How can you tell which is the best deal?

A federal law known as the Truth-in-Lending Act (TILA)  helps you shop for credit.  Enacted in 1968, it is a powerful tool to compare different offers of credit and choose the least expensive.  In a marketplace where you don’t have a lot of friends, the Truth-in-Lending Act is your friend.  But it only works if you use it!

TILA is a disclosure law.  “Disclosure” means “telling.”  TILA does not regulate how much a creditor may charge.  Rather, TILA makes every extender of credit disclose its terms in a uniform format, in a timely way, so that you can compare offers of credit and choose the best buy.

A transaction is covered by TILA if it involves the extension of consumer credit by a creditor.  Consumer credit means credit for your personal, family, or household use.  (That is to say, this law does not apply to business or commercial transactions.)   A creditor is a person or company that routinely engages in credit transactions.   (That is to say, when your parents lend you money, it’s not covered.)  Some transactions of more than $50,000 are not covered by TILA, but because documents are prepared by commercial printers in formats designed to comply with the law,  you often get the benefit of its main disclosures in such transactions as well.

You have almost certainly encountered TILA whether you know it or not.   This  Sample used car contract  illustrates the standard format of boxes highlighting the key terms of the transaction.  In future posts I will discuss each of these, beginning with the most important terms, the Finance Charge and the Annual Percentage Rate.

 

 

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What I know about Elizabeth Warren

Even Doonesbury heroine Joanie Caucus is dying to know whether consumer champion Elizabeth Warren will run for the U.S. Senate.  Scott Brown’s campaign machinery can’t decide whether to tar her as a “liberal Harvard professor” or a carpetbagger from Oklahoma.

I don’t know whether the Senate is the highest and best use of Dr. Warren’s talents now that President Obama has decided not to nominate her to head up her brainchild, the Consumer Financial Protection Bureau.  I don’t know how she would weather the absolute weirdness that characterizes modern political campaigns.

But here are three things I know about Elizabeth Warren, which you will know too if you pick up her 2003 book,  The Two-Income Trap (co-authored with her daughter Amelia Warren Tyagi). The community of consumer protection lawyers has known her for a long time, since she spoke at one of our professional conferences soon after the release of that book.  That was several years before the current predatory lending crisis and recession broke, vindicating many of her predictions.

  • She is very effective at linking personal stories to prescriptions for policy, unlike many liberal political candidates.
  • She has a great understanding of the unifying potential of consumer debt as a political issue.
  • She won’t roll over for anybody.

My favorite story, found in the chapter of the book entitled “The Cement Life Raft,” recites Dr. Warren’s interactions with Hillary Clinton.  In 1998, when Ms. Clinton was First Lady, she asked for a private briefing from Dr. Warren on a proposed bankruptcy law that would have made it harder for families to discharge debts.  Warren succeeded in convincing her that the “reform” law, which was widely believed to be supported by then-President Bill Clinton, was bad for children and families.  And indeed, when the Republican-led Congress passed the law in 2000, President Clinton vetoed it.  But in 2001, when the bill passed Congress again in substantially the same form, then newly elected Senator Hillary Clinton — having received $140,000 in campaign contributions from the banking industry — voted for it.

A close second is the story of Dr. Warren’s brief consultancy for the country’s largest credit card lender, which asked her to suggest policies that would help the bank cut its losses from cardholders in financial trouble.  The nub of her recommendation “boiled down to a single, not very startling idea:  Stop lending money to families that are already in obvious financial trouble.”  The highest ranking banker in the room cut her off, responding, “We have no interest in cutting back on our lending to these people.  They are the ones who provide most of our profits.”

This 2003 book also contains the germ of the idea that became the Consumer Financial Protection Bureau:  “The argument for re-regulation of consumer lending is a lot like the argument for regulating any other useful but potentially dangerous product.  Consider the toaster.  … No toaster manufacturer may peddle toasters that have even a 1 percent chance of catching fire.  Toaster makers (and conservative economists) could point out that riskier toasters could be made more cheaply… Companies might put special disclaimers and instructions on their toasters, telling customers how to extinguish the fires themselves.  But as a nation, we have collectively decided that the risks posed by an unregulated toaster industry are not acceptable.  …. Predatory loans may not set houses on fire the way a faulty toaster might, but they steal people’s homes all the same.”

Isn’t this the kind of clear, fresh, humane prose you’d like to hear more of in a political campaign?

 

 

 

 

 

 

 

 

 

 

 

 

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Down payments: the good, the bad and the ugly

In discussing the predicament of my prospective client “Irene,” I opined that she made a mistake by giving the dealer a large down payment when she first agreed to buy her car.  But last week, discussing the high cost of “gap” insurance, I mentioned that one way to avoid owing more than your car is worth is to increase the down payment.

So which is it?  Is a large down payment good or bad?

As is so often true in the byzantine world of car finance, it helps to separate out two different functions of a down payment.  Or, rather, the functions of a down payment at two different points in a typical transaction.

The first document you sign in a car deal is the Motor Vehicle Purchase Contract (MVPC), which identifies the car and states a price.  The dealer wants to sell you that car, but only if you can come up with a way to pay for it.  You, for your part, may want to make sure that the dealer doesn’t sell the car to anyone else in the meantime.  You want to hold the dealer to his promise to sell you that particular car.  That’s especially important in the world of used cars.

What makes a promise into a legally binding contract?  In legalese, it’s called “consideration”:  basically, you give something in order to make the other person’s  promise binding.  This is the legal function of a down payment given at the time you agree on a car.

But the dealer isn’t looking at the down payment in that way.  The psychological function of the down payment is as a hook to make sure you buy the car on the terms he will offer later.  The dealer will request as a down payment an amount that he figures you can’t afford to lose.

He’ll ask for you to pay it right away and write the amount on the contract in the space  where it says that you forfeit that amount of money if you decide not to take the car.  If you don’t mention an amount, he’ll ask for what he think you can afford to pay… but not afford to walk away from.

But a dollar is enough to be legal consideration.  At this point, you want to put down the absolute minimum amount necessary to hold the car, and then only if it is important for you to hold the car.  Otherwise, there is no legal requirement for any down payment.  It’s all psychology.  You want to be able to walk away from the deal and shop elsewhere if any problems arise.   The dealer wants to make it very hard for you to do that.

If you can’t pay cash for the car, you will then sign some documents arranging for financing.  Either you’ll get a loan from a bank or credit union, or if financing will be arranged by the dealer, you will sign, some hours or days later, a Retail Installment Sales Agreement (RISA).   Either way, at that point it’s in your interest to put down as large a down payment as you can, to minimize the portion to be financed and reduce or eliminate the “gap” between what you owe and what your car is worth.

 

 

 

 

 

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Of payment schedules and gap insurance

To recap, we’ve been talking about my friend “Irene,” who bought a car she couldn’t afford, and then the dealer talked her into a second deal …. to pay even more money for a less valuable used car!

When I looked at Irene’s paperwork for the second transaction, here is what I saw.  This Retail Installment Sale Agreement contains key disclosures required by a law called the Truth in Lending Act, or TILA.

Irene’s second contract

The first thing I noticed was the Total Sale Price, defined as “the total cost of your purchase on credit, including your down payment.”  It was more than $3,000 higher than the figure on the first contract.  That told me immediately that the dealer had taken advantage of Irene.  She was trying to downshift, yet wound up in a more expensive deal.

Then I looked at the Payment Schedule.  Irene was looking to reduce her payment below $300.  The monthly payment shown on this contract is $299.98.  How did the dealer get the payment to be a hair under $300?  By stretching out the time to 78 months — that’s six and a half years.  Irene never noticed that her new contract was three months longer than the first one.   And the first one, at 75 months, was plenty long to begin with.

There’s no law regulating how long an installment sale can be for.  Dealers know that customers often just look at the monthly payment and don’t consider the consequences of having a car not paid off for many years.  Long contracts cost you money.

When it takes so long to pay down the debt, it means that you owe more than the car is worth for a long time.  If during that time you get into a serious accident,  such that your insurance company “totals” the car, you’ll still owe money to the finance company.  That’s bad for you and maybe worse for the finance company.  That’s why dealers urge you to buy gap insurance.

Though often written as “GAP,” like an acronym, “gap” is just a description of what is being insured:  the “gap” between the car’s value at the time of an accident, which is the most that a collision policy will pay, and the remaining indebtedness that you owe on the car.  Irene’s contract calls for her to pay $700, plus the cost of financing that $700 over 6-1/2 years, for gap insurance.

Is gap a smart purchase?  It’s hard to say.  How long will the coverage last?  Will you be insured for as long as there is a gap, or only for a couple of years?  The dealer dictates the price for this product because it’s not really practical for a consumer to buy it from another source. Most such products involve a high markup by the dealer.

Another way to approach this question is:  if gap insurance seems necessary, think about whether you can reduce or eliminate the gap to the point where you can self-insure against this risk.  Maybe you’re buying too expensive a car.  Maybe the interest rate is more than you need to pay.  Maybe you should increase your down payment,  or insist on a shorter period of payments even though that means a higher monthly payment.  Maybe you have, or can start, a savings account, to pay off any gap in the unlikely event of having your car totaled in an accident.

Cars are expensive enough; what’s really awful is to have a deal padded with financing charges.  Under TILA, certain kinds of insurance, including gap, are not counted as part of the Finance Charge if you are given the choice whether or not to buy them.  But conceptually, gap insurance is part of the cost of credit.  If you can buy a car without buying gap insurance, you will save money in the long run.

 

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With the benefit of hindsight…

To recap from last week:  first Irene got into a car deal that was too expensive.  When she went back to the dealership and asked them to help her get out of it, she wound up agreeing to pay three thousand dollars more for a smaller, more heavily used car than the first one!

What might Irene have done to avoid getting into this mess?  With the benefit of hindsight, Irene made several common mistakes in buying her car.

First, she didn’t know the value of the cars she agreed to buy.    Maybe there was a price written on the windshield, maybe not.  But Irene hadn’t done any comparison shopping or research to know whether those stated prices were a good value.  In fact, the supposed cash price for the first car Irene agreed to buy, as stated on her Motor Vehicle Purchase Contract, was inflated by the $2,500 the dealer “gave” her as a trade-in on her old car.   Irene should have known her old gasping clunker wasn’t worth anywhere near $2,500.   But she didn’t make the connection between the trade-in allowance the dealer graciously offered and the price she was agreeing to pay for the new car.  Dealers don’t “give” you anything!  What appears to be given with one hand is always taken away with the other!  Similarly, when the dealer agreed to take car #1 as a trade-in for car #2, Irene didn’t know or didn’t notice that the new contract called for her to pay more than $16,000 for a car that, according to Kelley Blue Book, she should have been able to buy from a dealer for $13,000.

Second,  Irene gave up her bargaining power at the beginning by signing over her trade-in, putting down a large cash down payment, and driving away in car #1 before she had been presented with a contract for the financing (called a Retail Installment Sales Agreement, or RISA).  That is to say, she took possession of the car before knowing how she was expected to pay for it.

Dealers love to do this to customers — treating the financing as if it were some kind of minor detail.   This has both a psychological and a practical dimension.  Psychologically, you become invested in owning the car and not inclined to give a critical reading to the RISA when it’s put in front of you a few days later.  Practically,  even if you read the RISA and find that the interest rate is much higher than promised, or that the dealer made your monthly payments low by dragging out the contract to 4, or 5, or 6-1/2 years, even though you have a perfect legal right to opt out of the deal, the dealer will make it very difficult to do.  He’ll tell you there’s some reason he can’t return your trade, or he won’t refund your down payment.  He has already run a credit check and knows that you don’t have the option  of going elsewhere without the down payment. He has you in a vise.

Third, and related, Irene didn’t insist on taking the RISA home to review at her leisure before signing it.  Once you sign the financing contract, you are stuck with it.  Dealers play on the idea many people have, deep in their mind, that you have three days to cancel a deal if you decide it was a bad idea.  Unfortunately, this “cooling-off period” applies only to a very small set of contracts:  basically, refinancing home mortgages and door-to-door sales.  Irene’s RISA said, correctly, that  NO COOLING-OFF PERIOD applied to her contract.

Of course, dealers don’t want you to read the contract, much less shop it around to compare against other sellers, and have a well-developed set of techniques to prevent you from exercising your rights as a buyer.  The chief method, as mentioned above, is to present the contract after you already feel committed to buying the car and have no alternative financing lined up.  Another favored method is to have a stack of papers, most of which are unimportant, and run you through signing them all without reading them.

The RISA is the most important document you sign when you have a dealer arrange financing for the car.  It includes all the key terms you need to know whether you can afford the deal, whether it’s a good deal, and what will happen if the deal breaks down.  Part of the RISA is a set of uniform disclosures required by the Truth in Lending Act:  the Amount Financed, Finance Charge, Annual Percentage Rate, Total of Payments, and the payment schedule.  In columns to come I will talk about the importance of each of these elements.

 

 

 

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It’s a jungle out there!

I hate it when a client comes in with a problem I can’t solve.

Just the other day I met a women I’ll call Irene, who was desperate for me to find a way to relieve her from an agreement to buy a car.   Irene’s not an impetuous kid.  She is retired from a professional career,  living on a fixed income.  Here is her story.

Irene’s old car was dying.   She went to the showroom of a large franchise dealer in new and used cars, explaining that she desperately needed to replace her old clunker so she could get a part-time job.  The salesman asked if she could afford $65 a week, showed her a midsize sedan that was almost new, and said he’d give her $2500 for her trade-in.  That sounded good to Irene.  She drove the new sedan home that same day.  Two days later she went back to sign the paperwork.   As promised, there was a $2500 credit for her trade, the interest rate was a reasonable 5% from a credit union, and the monthly payment was not too much over $300.

But it didn’t take long for Irene to realize she really couldn’t afford the payment.  That was when she read over the installment sales agreement and saw that she was committed to 75 payments (6 years + 3 months); also,  the dealer had tacked some extras onto the car’s price, including an extended service contract for $1700 and “gap” insurance for $700.   (Later, Irene tried, but couldn’t explain to me what gap insurance was.)

She went back to the dealership and asked if they could  modify the contract or substitute something cheaper.  The dealer obligingly produced an entry-level compact with 40,000 miles on it and offered to let her defer the first payment for a few months so she could find a job in the meantime.   Within an hour or two Irene had signed a new Retail Installment Sales Agreement.  She was trading in the newer, larger car for a credit of about two thousand dollars.  The interest rate was now a few points higher.  The first monthly payment was deferred by a few months, but then it would be just a few dollars cheaper… and the term of the agreement was up to 78 months.  And the price of the extended service contract, curiously, had increased by almost a thousand dollars.

I studied the two contracts.  You know, I said, the total amount you will be paying, over the next 6-1/2 years,  is three thousand dollars more than under the previous contract  — for a much less valuable car.  I pointed to the part of the contract that said, in rather large type:  “No Cooling Off Period.”  Unless the dealer agreed to rescind this contract, which was unlikely, Irene was stuck with it.

What could she have done to prevent herself from getting into this trap?

In future posts I’ll talk about how to read sales contracts, especially installments sales contracts for cars, and about other tricks and traps in  dealer-arranged car financing.

But here’s a sneak preview:  It’s a jungle out there.  There are almost no limits on what a car dealer can charge for a car, for add-ons, or for the cost of credit.    There are laws to protect you… but mostly by requiring that key terms of a deal be disclosed in a way you can understand before you sign your name to a contract.   The key law is called the Truth in Lending Act, and it only helps if you use it.

 

 

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