One of the latest trends in “buy here, pay here” used car sales is the self-styled claim of the availability of “interest-free financing.” Dealers are promoting sales by advertising that installment sales will be free of finance charge; and that customers can make purchases over 36, 48 or even 60 months without a financing cost. Too good to be true? Well of course it is.

The Federal Reserve Board (FRB) asserted ages ago that so-called interest-free financing has the carrying cost of a deferred payment transaction embedded in the cost of the goods. That is why the Federal Truth-in-Lending Act (TILA) requires disclosures to be made under the Act even if the credit seller asserts that it does not impose any finance charge in connection with a credit transaction with a term of more than four months.

The reality is that most interest-free contracts are not held in the seller’s account portfolio, but rather are discounted immediately to a third-party assignee. The amount of the discount generally represents the true carrying cost of the transaction.

The primary way that the FRB looks at interest-free transactions under TILA is to determine the true carrying cost or finance charge by comparing what the seller charges a cash buyer for the same goods. The problem with undertaking this analysis in the used car market is that used cars are not fungible, and such comparisons are practically impossible to make. Even when the regulators have attempted to be ghost shoppers—asking for the price differential if the shopper paid cash instead of taking the interest-free alternative—the variables in auto sales have proven to confuse any meaningful analysis.

So, what’s next? Are claims of interest-free installment sales just here to stay? Maybe not.

The CFPB is interested in this issue of interest-free financing. And, while the Bureau will still have the historical problem with proving the difference between a true cash price and a deferred payment price, the CFPB’s UDAAP tool may be useful to open an attack on whether a financing transaction really is interest-free financing. Under a UDAAP analysis, the CFPB may be able to prove the elements of unfair, deceptive or abusive conduct in such transactions, in order to put the brakes on the marketing of used cars in this fashion.

Please Note: This is the one hundred seventy-sixth blog in a series of Back to Basics blogs, in which relevant and resourceful information can be easily accessed by clicking here.