What Is Dealer Financing?

Dealer Financing Explained

A man looks at a car.
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Dealer financing is a type of financing in which the retailer helps you secure a loan through partner financial institutions. Once the financing is in place, the dealer may sell your loan to a bank, credit union, or finance company.

Let’s review how dealer financing works, what it offers to potential borrowers, which alternative financing options exist, and how to obtain this type of financing.

Definition and Examples of Dealer Financing

With dealer financing, the retailer serves as a middleman between you and the institution lending the money. The retailer establishes relationships with certain banks or credit unions so that you have on-site financing options. When you want to get a loan for a purchase through the retailer, the retailer collects your information and helps you complete a loan application. 

  • Alternate names: Dealer-arranged financing

Dealer financing is most widely used to buy and finance vehicles. Car dealerships will often advertise this convenient option to customers who come to look at cars on the lot and haven’t obtained financing elsewhere. 

Dealers selling other high-cost items, such as boats and motorcycles, commonly offer dealer financing.

How Dealer Financing Works

During the dealer financing process, you work with the dealer to negotiate a deal. For example, the retailer can help you find a loan offer with an affordable monthly payment and desired loan length. In some cases, the dealer financing offer may even include special promotions, especially if a manufacturer has its own financing company. For example, a customer buying a specific vehicle model may get a 0% financing offer if they agree to a shorter loan term.

To qualify for dealer financing, you’ll need to meet similar requirements as you would when getting direct financing through a bank. Common requirements include having a steady income, good credit score, and available funds for any required down payment. You’ll need to show that you can afford the loan payment along with the other debts you already have. If you can’t get a high enough loan for the purchase, you may need to increase your down payment to decrease the amount you borrow and, in theory, reduce your monthly payment.

A potential lender will usually give the retailer a “buy rate,” which is the interest rate that the lender is willing to charge for the loan. This rate is usually at a discount compared to what the customer will pay, giving the dealer a chance to mark up the interest rate and make additional revenue. 

For example, a lender may approve you for an auto loan and offer the dealer a 4% buy rate. The dealer marks up the rate to 5% for a 1% profit. The dealer presents you with a 5% interest rate, you accept, and the paperwork for the purchase and loan proceeds. 

Once you accept the loan, you’ll typically send your monthly payments to the financial institution that services the loan.

Pros and Cons of Dealer Financing

Pros
    • Convenient application process
    • Potential promotional offers
    • Ability to negotiate terms
Cons
    • Higher interest rates
    • Potential for less transparency
    • Less flexibility for lender options

Pros Explained

  • Convenient application process: Dealer financing is convenient, since you’ll shop for your vehicle and fill out loan paperwork to get offers on the spot. This means you don’t have to spend time researching banks and filling out multiple applications beforehand.
  • Potential promotional offers: Dealerships might take part in special programs, such as discounts on certain vehicles or a low interest rate, to encourage creditworthy buyers to choose dealer financing.
  • Ability to negotiate terms: Although dealer financing can offer less flexibility than direct financing, you can negotiate interest rates or different loan terms. The dealer may agree to charge less markup so the loan is more affordable.

Cons Explained

  • Higher interest rates: The dealer can add a markup to the buy rate that the associated financial institution offers them. This means you may end up paying a slightly higher interest rate than when borrowing directly through a bank.
  • Potential for less transparency: Since the dealer will want to profit from the deal, there may be less transparency about interest rate markups. You might also not have enough time to thoroughly research all the offers available to you.
  • Less flexibility for lender options: When you choose dealer financing, you’ll only get offers from the financial institutions associated with the dealer. This can lead to less flexibility in loan terms than borrowing directly from a lender.

Alternatives to Dealer Financing

Whether you’re seeking a loan for a car or other type of vehicle, you might find dealer financing appealing due to the convenience associated with it. However, you can look at a few more options that might lead to easier approval or better loan terms.

In-House Financing

Often advertised to people with poor credit, in-house financing results in the dealer directly offering you a loan without the use of a third-party financial institution at all. The dealer has full control over your loan terms and may opt not to do a credit check. You’ll make your payments directly to the dealer.

The Consumer Financial Protection Bureau (CFPB) warns that in-house financing may let you borrow more than the car is worth, possibly resulting in thousands of dollars of extra payments.

Like with dealer financing, you complete the loan application at the point of purchase, and you can only buy something through that business. You often pay a higher interest rate in exchange for the possibility of getting approved with a worse credit profile. 

Direct Financing

Direct financing gets rid of the dealer acting as the middleman, since you’d reach out to a credit union or bank about the loan you need. You may get better terms than with dealer financing because your loan lacks the dealer’s markup.

You’d usually fill out a preapproval application and provide your financial and vehicle purchase information to the financial institution. You’d know all the loan terms before you head to the dealership. You also get the benefit of being able to compare multiple offers to find the best terms. 

How To Get Dealer Financing

Getting dealer financing is often as simple as going to the dealership and asking for it. However, your dealership’s website might offer a preapproval application that you can fill out beforehand and save some time at the dealership. 

When filling out the application, you can expect to answer questions about what you wish to purchase, how much money you’ll put down, and how much income you make. The dealer’s finance department will usually also ask for some documentation, such as a driver’s license and recent pay stubs to verify your income. When the dealer submits the application to lenders, they will check your credit score, credit history, loan amount, and debt-to-income ratio. These factors influence your approval decision, as well as your interest rate. 

Once the dealer gets a response from potential lenders, you’ll need to review the offers and decide which of them to accept. After you’ve gotten approved and made your decision, you’ll complete the paperwork for the loan and purchase. You’ll deal with the financial institution servicing the loan moving forward.

Key Takeaways

  • With dealer financing, the retailer uses its network of lenders to provide a loan for the customer and then sells the loan to a financial institution. 
  • Dealers mark up the interest rate quoted by lenders (the buy rate) so they can get a profit from this financing arrangement.
  • Car dealerships often offer this type of financing, as do retailers selling motorcycles and boats.
  • Dealer financing offers benefits such as convenience, potential promotions, and negotiable terms, but it can also lead to a higher interest rate, less transparency, and fewer lender options.
  • You can consider in-house and direct financing as alternatives to dealer financing.