Car Dealer Financing or Credit Unions: Which Is Best for Me?

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Should you use dealership financing or go with a credit union? Here’s what to consider.

You’re ready to buy a car. Or, you’re at least mapping out ways to fund your auto purchase. But who should you trust to finance your new vehicle — a dealership’s financing program or a credit union?

Financing through a dealership is convenient. You’re already buying a car from them, why not finance the purchase through them too? On the other hand, if you’re a member of a credit union, you might have access to more competitive interest rates. So, which should you go with?

We’re here to help you make an informed personal finance decision. Let’s explore the various factors you should weigh when choosing dealership financing versus credit union financing, starting with why dealers want to handle your auto loan in the first place.

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Why Car Dealerships Want to Finance Your Auto Loan

Taking out an auto loan is normal. In fact, you’d be in the minority if you upgraded your down payment into an all-cash purchase. According to Experian, almost 86% of all new cars are financed.

But why do car dealerships want to handle your financing?

Car dealerships are for-profit businesses — they’re incentivized to make money and return value to the dealer’s stakeholders. How? Primarily, by buying cars from auto manufacturers and then selling them for a higher price. But that’s just one of the ways dealerships can generate profit.

They also make money through selling insurance products and financing, such as issuing car loans to help patrons finance their vehicle purchases.

In most cases, when you finance through a dealership, one of two things happens. The dealer could act as a middleman, outsourcing your loan to a third-party lender (such as a bank or credit union) in exchange for a commission. Or if the dealership’s affiliated automaker has an internal financing program, it can process your loan in house. This is known as captive lending.

What is captive lending?

Despite the disconcerting name, captive lending is a common industry practice among dealerships and auto manufacturers.

A captive finance company is a wholly-owned subsidiary of an auto manufacturer or dealership. For example, Ford dealerships often allow car buyers to finance through Ford Credit, the financing branch of Ford Motor Company. Automakers like General Motors and Toyota, as well as online dealers like CarMax and Vroom, have their own captive financing arms too.

Buy-here, pay-here dealerships vs. captive lending

Buy-here, pay-here (BHPH) programs function similarly to captive financing in that they provide a convenient loan option for car buyers. However, BHPH programs are typically designed to help car buyers with bad credit get an auto loan. As a result, their rates can be exorbitant compared to traditional loans and captive financing.

In other words, monthly loan payments can be exceedingly high and tough to manage. Generally, it’s wise to avoid these sorts of loan arrangements.

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The Pros and Cons of Auto Financing Through a Dealership

Nowadays, there are a lot of ways to buy a car — online dealers like Carvana even offer delivery. That said, although buying a car online is easier than ever, auto dealerships still offer a convenient option for exploring and test driving a broad selection of makes and models.

Adding to that convenience, it’s common for dealers to have their own financing programs too.

Once you have your eyes set on a particular car, you’d fill out a credit application, and the dealer would process it to see if you qualify. As we discussed, they’ll either submit your application to their third-party lender network or forward it along to their affiliated financing program.

The advantages of dealership financing

Beyond convenience, financing through a dealership can provide a monetary benefit. Just like a clothing retailer runs promotional sales, it’s common for dealerships to offer cash rebates and financing deals too.

For example, a dealership might struggle to offload a particular model in its inventory. To stir up interest and sell units, it could offer 0% financing for 48 months — which may entice more potential buyers to visit the lot.

You can only get these kinds of deals from a dealership’s captive financing arm, and you might need to have excellent credit to be eligible. Still, incentives can give dealership financing an edge.

Also, compared to credit unions, it could be easier to qualify for dealership financing if you don’t have the best credit. That said, there is a caveat. Lower credit scores often translate to higher interest rates.

The disadvantages of dealership financing

Alas, sometimes convenience comes at a price. It’s not uncommon for dealerships to mark up the loan rates they receive from their lender network. As a result, you could find yourself paying a lot more in interest over the life of the loan.

That’s especially true if you take out a loan from a buy-now, pay-here dealership. If you can qualify for auto financing from your credit union, you’d likely get a better rate from them versus a dealer.

Also, if customer service and 24/7 support are important to you, dealership financing may not be the best option. Car salespeople tend to have an unsavory reputation. While that’s obviously not the case for all car dealers, it’s not unreasonable to say credit unions have a general customer service advantage.

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The Pros and Cons of Auto Financing Through a Credit Union

In case you’re unfamiliar, a credit union is a type of financial institution. Like banks, they can provide a variety of financial services, from retail banking and credit cards to personal loans and investment products. And, of course, auto loans.

Whether you’re already a member of a credit union or you’re considering joining, it’s worth exploring the benefits of financing through credit unions.

 The advantages of credit union auto financing

Credit unions are nonprofits in which members are also owners. This can allow them to offer lower interest rates. Conversely, other financial institutions (and dealerships) are for-profit businesses. So, they may charge higher interest rates to increase their profits.

Beyond competitive terms, credit unions are well known for offering high-end customer service. “Courtesy and helpfulness of staff members” is routinely the highest scoring metric for credit unions, according to the American Customer Satisfaction Index.

The disadvantages of credit union auto financing

On the other hand, dealerships do have a firm advantage in one area — incentives and special promotions. You’ll occasionally see dealers offer 0% financing for a certain loan term. In essence, this is an interest-free vehicle loan. You’d be hard pressed to find a credit union, or any traditional lender for that matter, that’s willing to extend an auto loan for free.

Additionally, credit unions have membership requirements. For example, USAA is limited to members of the military and certain family members. And if you aren’t a member, you won’t be able to access a credit union’s auto loan program.

What rate can I get? What rate can I get?

How To Decide Between Dealer Financing vs. Credit Union

You may still be on the fence about dealer financing versus credit union financing. That’s okay — there’s a route you can take to keep your options open. You can try to get preapproved for an auto loan through your credit union.

If you choose to preemptively apply for auto loan financing, your credit union will assess your financial profile to see if you qualify. This likely involves checking your credit score and credit history, as well as reviewing your employment and monthly income.

If you’re approved, your lender will come back with your potential loan offer — including interest rate, loan term, and maximum loan amount. With your loan terms in hand, you can then compare them to dealer financing options.

Getting preapproved provides an added benefit of knowing your budget when you walk onto a lot (or look around online). Moreover, if you’re working with a particularly salesy car salesman, it can help prevent them from sneaking in unwanted add-ons.

Check your credit before you decide

Regardless, before you apply for a loan, review your credit scores and history first. Don’t worry — you can check your credit scores for free.

If you have lower credit scores that are unlikely to qualify for financing, you can work on improving your credit before applying. This will save you from pointless hard inquiries, which will ding your score slightly. Plus, if you boost your score, you can increase your chances of getting the best loan.

Refinancing Is Always on the Table

You can’t always get the best rate. It’s not fun to hear, but it’s the truth.

Maybe you recently took out another big loan, which caused your credit score to drop. Or maybe you don’t have much credit history yet. Regardless, you aren’t necessarily stuck with whatever interest rate you get. You can explore refinancing your existing loan with a new loan, which can help borrowers significantly lower their rates and monthly payments.

According to RateGenius’s 2022 State of Auto Refinance report, borrowers who refinanced their auto loans cut their rates by 7% on average — good for nearly $1,158 of annual savings.

So, if you don’t get the lowest rate when you take out your initial loan, don’t forget that refinancing is always on the table. Especially if your credit or your general financial situation improves.

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