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A Car Lending Change That Both Borrowers & Lenders Can Get Behind

The Consumer Financial Protection Bureau has reportedly made an offer to a leading auto lender that it can't refuse.

According to a recent Wall Street Journal article, the regulatory agency is proposing a dealer incentive of sorts to Fifth Third Bank: If the lender agrees to limit the interest-rate markups that auto dealerships and brokers, acting as middlemen, place on loans that are later financed by the bank, the CFPB would consider a reduced settlement in its ongoing industry-wide probe into possible discriminatory lending practices.

There's no word yet on whether Fifth Third would accept the offer reported by the The Journal — the bank didn't comment for the article. The bank would also not be the first lender to reach such an agreement with the CFPB — Honda's American financing arm agreed to limit markups in July.

The reported proposal, which has the potential to attract bagfuls of hate mail from the agency's political adversaries, makes sense. And not just because it's a means to an end for curtailing the potential discriminatory lending practices in the auto industry as a whole that have been under investigation by the CFPB and the Justice Department. It actually presents lenders with the air cover they need to rein in a practice that's run amok.

Some time ago I worked with a finance company, which, like most of its competitors, permitted similar interest-rate markups that our soon-to-be borrowers would be forced to pay over the term of their loans.

After taking a closer look at a fair-size sampling of the loans the company ultimately financed, I realized that in at least half the cases, the middlemen stood to make the lion's share of the profits.

Now, some would say that's as it should be because these folks typically expend more time, effort and dollars to win, document and close the deals than do the lenders to which these are later conveyed. Maybe so, but what if the borrower were to default on his or her loan? The lender (or the investors who may ultimately be brought into the mix) have no way of knowing if the deal it agreed to fund will be profitable until it successfully collects three, four, five or more years' worth of payments—a risk that's amplified when the rates have been pumped up.

That's because although it's true that loans are typically priced after taking into account a prospective borrower's ability to fully repay his or her obligation, charging too high a rate may well lead that borrower to do what lenders fear most: default on the debt.

The CFPB is justifiably worried about that and the potential for these interest-rate markups to be used to discriminate against women and minorities. So, too, are its detractors justifiably concerned about what they perceive as a regulatory intrusion into the heart of a private business' competitive practices.

Yet, rather than viewing the bureau's move as an attack on the free enterprise system, I suggest the lenders and investors that are left holding the bag on marked-up loans should just say thank you, then rework their policies to limit this flexibility, and renegotiate the arrangements they have with the middlemen who've prospered at others' expense.

This story is an Op/Ed contribution to Credit.com and does not necessarily represent the views of the company or its partners.

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