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New Car Financing 101: Bank vs. Dealership

bank vs. dealer financing

The time has come for you to purchase a vehicle and you are both excited and nervous. The excitement comes from the opportunity to get behind the wheel of something new and different; and the nervousness comes from the process of actually acquiring an auto loan.

One thing you know for sure is just about any auto dealership you visit will be happy to simplify the process of securing a loan by offering its own. But is taking this route better than working with an independent financial institution? How can you determine which form of new car financing is right for you?

The Basics of New Car Financing

Financing a vehicle is a relatively straightforward concept. If you don’t have the money to purchase a vehicle in cash, you can acquire a loan from a financial institution that will essentially purchase the vehicle for you, then allow you to pay the vehicle’s cost back in installments with interest.

According to the Federal Trade Commission, there are two primary ways individuals choose to finance a vehicle: direct lending and dealership financing.

  • Direct lending: The FTC defines direct lending as obtaining a loan directly through a finance company, such as a bank or credit union. When a person purchases a vehicle via direct lending, he or she agrees to pay the amount financed, along with an agreed-upon finance charge, over a specified period of time.
  • Dealer financing: Dealer financing is an arrangement between a car buyer and dealership; the buyer agrees to pay the amount financed as well as a finance charge over a period of time. In some cases, the dealership might retain the contract, but in most cases, it sells the contract to an assignee, ie. a bank, finance company or credit union, that then services the account and collects the payments.

There is a common debate as to whether direct lending or dealer financing is the best option to choose when pursuing an auto loan. In actuality, both options have pros and cons that should be explored before choosing either.

The Pros and Cons of Direct Lending and Dealer Financing

While direct lending and dealer financing are similar, the primary difference between the two is where you acquire your auto loan.

As noted by the FTC, if you work with an auto dealer, you’re acquiring dealer financing; if you work directly with a bank or credit union, you’re acquiring a direct loan.

But what are the pros and cons of taking either route?

Direct Lending Pros and Cons

Before heading to your bank or credit union to apply for an auto loan, consider the pros and cons of taking this option:

Pros

  • Straightforward borrowing: One major benefit of working with a bank when borrowing an auto loan is the straightforward process involved. The lender is not trying to sell you a vehicle. Instead, it is making money on a loan, which means you avoid vehicle price manipulation.
  • More leverage with the dealer: Acquiring a loan from a lender is similar to bringing your own cashier’s check. You are essentially paying for your vehicle in cash, which gives you more leverage with the lender. Now you have the opportunity to name your price, which should be lower than the sticker value you see.

Cons

  • Tougher lending criteria: One disadvantage of working with a bank or credit union is tougher lending criteria. Because the establishment’s business isn’t selling cars for a profit, but ensuring its borrowers pay back their loans, it doesn’t just lend to anyone. This means, in order to qualify for an auto loan through direct lending, your credit score and history will likely need to be pretty good.
  • Lack of incentives: Banks and credit unions that offer auto loans usually do not participate in lending incentives like 0 percent financing or bonus cash offers, unless they’ve developed a relationship with a specific auto dealership. This means your loan will probably come with no bells and whistles.

Car Dealer Financing Pros and Cons

Dealer financing is one of the most common ways individuals purchase vehicles. But is this the right route for you? Before deciding, examine the pros and cons of this arrangement:

Pros

  • Convenience: One of the biggest reasons individuals purchase vehicles through dealer financing is convenience. There is no need to visit an independent institution first, because the dealer makes contact with a bank for you.
  • Near-guaranteed approval: Dealerships have multiple financing relationships that ensure most applicants will receive a vehicle. It’s also beneficial to individuals who have better credit as they could have access to multiple financing options.
  • Incentives: Unlike direct lending options, dealer financing opens car buyers up to incentives such as low-rate financing and cash-back offers, which could help save buyers hundreds or thousands on their purchase.

Cons

  • Subprime loans: Auto dealerships have been known for offering their customers subprime auto loans, which are essentially high-rate loans issued to individuals with credit scores of 680 or lower. While subprime auto loans are not inherently bad, dealerships have gained a reputation for issuing high-rate loans to individuals whose credit scores are deserving of higher rates.
  • Hidden fees: Dealerships undoubtedly have a vested interest in each vehicle they sell. It’s for this reason that some who are known as predatory lenders will take advantage of individuals who lack an understanding of the lending process by imposing unnecessary hidden fees.
  • Less room to negotiate: Ever heard the saying “beggars can’t be choosers”? It often applies when attempting to purchase a car from an auto dealer. This is not to say that you can negotiate car prices with the dealer, but because the dealer is determining what type of financing you’re eligible for, it’s easy for you to negotiate down and still end up paying more in interest and other fees tied to the financing deal.

Choosing the Best Auto Loan Financing Option

Now that you know the pros and cons of both direct lending and dealer financing, which new car financing option is best for you?

Unfortunately, no one can tell you which scenario is best. The decision comes down to a number of factors, including how good your credit score is, how important incentives are to you, how badly you need a vehicle now and how good your negotiation skills are.

But no matter which option you choose, it’s good to arm yourself with the following tips to help make the process of financing a vehicle flow a bit smoother.

Car-Buying Techniques for Direct Lending and Dealer Financing

  1. Know your credit history: One reason dealer financing often results in individuals paying higher interest rates than necessary is the lack of knowledge buyers have before visiting a dealership. Take time to check your credit scores with the three major credit bureaus (Experian, Equifax and TransUnion), then examine what car loan rates are typically associated with those scores.
  2. Understand additional lending criteria: While credit history is a major piece of the puzzle, other criteria is examined when determining whether you qualify for a loan and how high your rate will be. For instance, a company might look at your length of employment and income as major determining factors. If you’ve only been employed for three months or you earn $1,000 per month but want to purchase a $30,000 car, it might be difficult to qualify.
  3. Learn what the dealer paid for the vehicle: If you’ve found a vehicle you like and want to negotiate — whether you’re planning to finance through the dealer or your own bank — it’s good to negotiate up from the invoice price of the vehicle you want, i.e. the price the dealer paid for the vehicle, rather than negotiating down from the sticker price.
  4. Avoid unnecessary dealership services: Car dealerships often offer car buyers a host of expensive services that aren’t truly necessary. Some include fabric protection, rust-proofing and paint sealant. These are services you can manage on your own that will save you hundreds on the total cost of the vehicle.
  5. Don’t be afraid to walk away: Whether you’re negotiating with a dealer after acquiring loan approval from your bank or are attempting to acquire financing straight from the dealer, if you don’t like the offer being presented by the dealership, you don’t have to cave and accept it. Instead, exercise your personal power and walk away.

It can be tough to decide whether working with a financial institution directly or securing new car financing with a dealership is the right road to take. Give yourself time to examine your personal circumstances and look at the deals being offered by both financial institutions and area dealerships. That way, you can make an educated and informed decision that will leave you with no regrets down the road.

Photo credit: Daniel Oines

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  • lee

    A friend of mine is thinking of buying a new car this weekend!!! I’m so sending this to him.

  • Freddie

    Great advice – when I leased my car I literally walked out of the dealership 3 times and wouldn’t settle. I finally got the car of my dreams for $100 a month less MSRP for my 36 mo. lease! Gotta be agressive