Implementing uniform GAP refunds: Costly but necessary

Automotive lenders should implement a uniform process for GAP refunds across all states they lend in to comply with Consumer Financial Protection Bureau guidelines despite the high cost of the process and a variation in state policies by state, some advisors say. 

Legislation differs by state regarding whether lenders are responsible for distributing GAP refunds to consumers, when a refund is warranted and how a refund is calculated.  

Lenders should adopt a uniform refund policy across all states and ensure that consumers receive refunds in each state the institution lends in regardless of state law, Mike Chalmers, co-founder and managing partner of aftermarket refund advisory company Blue Elk Advisors, told Auto Finance News. Chalmers served as director of sales and aftermarket at Mechanics Bank Auto Finance for nearly six years.  

“The argument that the lender has is, ‘I only refund GAP in states where it is required by law. The law does not require me in Arizona, for example, to refund customers if they pay off their loan early,’” Chalmers said. “The CFPB would come in and say, ‘You’re treating customers differently in different states because of where they reside, so by definition you’re discriminating based on location.’” 

Although a lender in that scenario would be abiding by the state law, the CFPB can still find it in violation because of discriminatory practices, Chalmers said. “If you’re willing to fight the fight with the CFPB, you’re going to lose,” he said. 

Several states, including California, Colorado and Massachusetts, have enacted laws in response to the CFPB’s yearslong concerted efforts against overcharging for add-on products or miscalculating refunds. 

Many states hold the lender accountable if consumers don’t receive correct refunds on GAP insurance. Since 2019, Colorado Attorney General Phil Weiser has completed settlements with 10 lenders over GAP refunds, amounting to $23.5 million in refunds issued to Colorado citizens, according to the AG’s website. 

Alabama, Nevada, Texas and Wyoming also hold the retail installment holder responsible for refunds. Lenders must be vigilant as more states have GAP refund legislation in the works, Chalmers said. 

New York, for one, does not have a law in place regarding GAP refunds, but the New York Department of Financial Services issued a letter in July that states auto lenders must issue refunds to customers for all eligible add-on products. 

Compliance is costly 

One of the difficulties of implementing a large-scale, uniform refund process is the costs associated with managing and issuing refunds, Chalmers said.  

“This is a terrible set of circumstances for a lender because all this does is cost money,” he said.  

To remain compliant, many lenders front the refund to the consumer before the dealer issues the money to the lender, Chalmers said.  

Lenders are “responsible to ensure that the consumer gets their refund, and the only way to do it is to write the check, but if the dealer doesn’t pay that back, now [the lender is] holding the bag,” he said. 

“If you’re [a large lender], you’re talking about hundreds of thousands of dollars a month in refunds that may or may not get paid back,” Chalmers said. “If [lenders] are getting 80% of the money owed back to them from the dealers, that’s pretty good so they’re eating 20% of that.” 

Meanwhile, in order to manage refund amounts, GAP insurance is the only product that nearly all lenders have a set maximum amount they allow dealers to charge, Chalmers said. 

Many lenders have a cap of $1,200 to $1,500 on GAP insurance, he said. The cap on GAP insurance costs has gone up by at least $500 over the past 10 years, which leads to higher refund amounts, Chalmers said. 

“They use [larger caps] as a carrot to get dealers to send more loans to them if they sell their product,” he said.