Car Buying: Should You Choose Dealer Financing?

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by Lindsay VanSomeren

People have a lot of opinions about dealership financing, and for good reason.

Dealership financing ranges from the truly awful to positively the best. Depending on your credit score and how you plan your car purchase, the interest rates you get might be the lowest option for you, or they might be the highest.

With so much variation, it’s hard to know what to make of dealership financing. The truth is that it’s actually not that complicated. You just have to understand how it’s different from bank financing, and then you can use it to your advantage to get the best rates on your next ride.

We’ll show you exactly how to do it. But first, we need to see how bank financing works, so that we can compare the differences.

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How Bank Financing Works

To get an auto loan from a bank or credit union, you’ll need to actually apply directly with them. If you want to compare your interest rates at different financial institutions (which is always encouraged), you can go to each one individually. That can take up a lot of time, and it’s one of the big deterrents for people to go rate shopping.

When you do apply for an auto loan through a bank or credit union, that’s who will actually be giving you the money, and who you will repay. It’s a contract between you and the bank or credit union.

Auto loans from banks are more popular than credit unions: 28% of auto loans were given out by banks while only 12% of auto loans were given out by credit unions in 2019, according to the National Automobile Dealers Association. That’s likely because credit unions have membership criteria, such as living in a certain location, working for a certain employer, or being a member of a certain group. They don’t just give out car loans to anyone. If you are eligible for credit union membership, however, you can usually get better interest rates on your loan than you can at a for-profit bank.

How Dealership Financing Works

It’s tempting to think of car dealerships as just selling cars. In reality, they sell a lot of things besides cars: car parts, car repair, and yes — car financing too. Car dealerships think of selling car loans as a product just as much as the car itself is a product. That’s what their financing departments and finance managers are for.

When you boil it down, though, getting your car financing at the dealership is often not the best deal, and it has to do with how their business model works.

When you find a car you want at a dealership and apply for financing, the salesman will send out your details out to a network of lenders — often the same lenders that you yourself can apply for a loan with, though not always.

Each lender will come back to the salesman with its best interest rate, known as the “buy rate.” The lender will then either get a pre-set fee (a “finders fee” or “referral fee” of sorts), or will add a few extra percentage points onto the buy rate for their own payment. Car dealers thus act as a middleman that get a cut of the loan, and that makes it more expensive for you.

“Buy-Here-Pay-Here” Dealerships

Some dealerships don’t operate in this way. If you’ve ever seen those dealerships advertising “buy-here-pay-here” or “no credit needed,” they’re accurate.

Those dealerships aren’t a middleman; they give you the car itself, and you repay them for it over time. But in return, these types of financing options are the most expensive of all, and they’re often targeted to the people who have the least ability to afford an overpriced loan.

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Pros of Dealership Financing

  • Can negotiate rates down: Dealerships are middlemen that take a cut of the loan, so you may have better luck negotiating your loan terms with a dealership rather than a bank or credit union.
  • Promotional financing: Dealerships often run promotional offers such as 0% APR financing, especially on new cars. Just remember to watch for any hidden catches or scams that can drive your overall loan costs up. Read the fine print to find out.
  • Can be more convenient: You can find a car, arrange the financing, and drive the car off the lot the same day if you want — but you’ll likely pay the price in the form of a less-favorable loan.

Cons of Dealership Financing

  • Can be very expensive: If you don’t put in the work to negotiate your rates, dealership financing is often the most expensive option of all. That’s especially true if you have bad credit.
  • Heavy sales pressure: Car salesman are notorious for roping you into spending more because they get you into focusing on the car payments rather than the long-term costs of the loan, along with other well-known dealer tricks.
  • Less personal customer service: Instead, you can work directly with the lender of your choice, like a credit union.

What If I Have a Bad Credit Car Loan From a Dealership?

If you have bad credit, here are some things you can do instead of relying on pricey “buy-here-pay-here” dealerships:

  • Save up more of a down payment
  • Apply for a loan with a cosigner or joint applicant
  • Work on building your credit history and credit score
  • Shop around more extensively with other lenders, especially credit unions
  • If you already have a car, sell it rather than using it as a trade-in. You’ll get more for it.

And if you do end up getting a bad loan from a dealership? No worries. You can always refinance your loan with a different lender.

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How to Use Dealership Financing to Your Advantage

All of this isn’t to say that dealership financing is inherently bad. The good news is that you can actually use it to your advantage — if you know how. It’ll take some extra work, but it’ll save you big bucks in the long term.

The idea here is to shop around for preapproved loan before you go car shopping. Try getting quotes from as many different banks and credit unions as you can. Then, pick the best quote, and apply for a preapproved auto loan. They’ll give you a piece of paper which confirms that you’re preapproved for a loan for $X at X% APR. This is your literal bargaining chip; your golden ticket.

Now, you can go car shopping. If you find a car you like at a dealership, they’ll try to sell you on a financing offer. Here’s where you can pull out your preapproval letter, and ask them if they can do any better. You can use it as a tool to negotiate your rate even lower.

And if they won’t negotiate it lower? Then you’re already likely set with the best financing offer available to you, and all you need to do is complete the application. Either way, you end up winning in this scenario.

Is Dealership Financing Right for You?

Dealership financing isn’t inherently good or bad. It’s a tool, just like anything else. If you’re not cash-wise, dealership financing can end up costing you big time.

But if you’re smart about it, you can use the very tool designed to cost you more in a way to get something for cheaper. Just make sure you really are getting a good deal if you opt for dealership financing.

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