When you opt for dealership financing, you’re using the dealer as a middleman between you and a lender. Often, this results in higher interest rates — and may afford you less protection as a consumer.

A dealership is certainly a convenient place to get an auto loan. You won’t have to fill out separate applications, and you can take care of it after you have found the perfect ride. But it frequently doesn’t make the most financial sense, especially if you have good credit and an established bank or credit union.

What dealer financing is

Both independent and franchise dealerships — dealers that work directly with a manufacturer — offer in-house financing. This may be through a finance company owned by the manufacturer, the dealership or a third party.

No matter the situation, it all boils down to financing offered to you through the dealership. When you buy a car, you will be able to fill out an application for an auto loan. If you are approved, you can use this loan to finance your car.

Dealer financing is typically considered a last resort by most experts. Dealers make a good amount of money off in-house financing because they mark up the rate you’re offered. For example, if you could qualify for a loan at 7 percent through a bank, you may receive an offer of 9 percent through dealership financing.

The best course of action is to get outside financing first. Banks, credit unions and online lenders all offer auto loans at competitive rates. Once you’ve been approved for another loan, it’s easier to negotiate a good deal with dealer financing if that’s what you want. Otherwise, you’ll be at the mercy of whatever finance company the dealer uses.

How dealer financing works

Dealer financing is designed to maximize convenience. You will typically be able to find, test drive and buy a car all on the same day. And while experts frequently recommend avoiding certain sales tactics, if you know you’re going to finance through the dealership, the steps are simple.

Find and test drive cars

Unless you are absolutely pressed for time, visit multiple dealerships. Your day spent test driving cars should be separate from your day negotiating price. You are under no obligation to do everything at once, and in fact, it may get you a better deal if you spread it out.

Salespeople may try to pressure you into a quick sale by citing scarcity. But if you are looking for a common trim on a common make and model, you will be able to find the exact same car again if it does get sold. So, if you are set on financing through a dealer, don’t be swayed by flashy pitches designed to squeeze more money out of you.

Meet with the dealer’s finance office

This is the crux of negotiation. Don’t show your hand too early, of course, and keep the focus on overall cost rather than monthly payment. It’s best if you show up preapproved by another lender. This gives you more room to discuss exact terms.

If you haven’t gotten a loan from an outside source, don’t worry. You’ll just need to reject offers for add-ons that you don’t want and don’t need. Ideally, your negotiations should center around the amount you’ll pay and the terms of the loan.

Once you have reached an agreement, you’ll fill out the finance paperwork. The dealer will send it to lenders it works with to see if you qualify for the loan.

Review offer and sign the paperwork

Here’s where you need to be careful. Some dealers may sneak in a clause that says your purchase is “pending approval” — and may still be up for change. Don’t close the deal or drive off the lot until you confirm that you have been approved by the lender at the rate you have been quoted.

Keep an eye on other details as well. But if you like the interest rate and terms you have been given, it’s time to sign the paperwork. Work out how the titling process will go and what you’ll need to send the lender. After that, it’s your car to drive and make payments on.

Who dealer financing is best for

Getting a loan through a dealership may be your best option if you don’t have great credit.

Buy here, pay here dealerships are the most common method to obtain a loan. Because the dealership and the finance company that lends money are owned by the same lender, there’s less overall risk. You’ll have an easier time buying a car, but it comes at a cost. These dealerships frequently require a large down payment and may quote you a high interest rate.

However, most franchise dealerships — dealers that work directly with manufacturers — also have a captive finance company. Similar to buy-here, pay-here dealers, a captive finance company works directly with the manufacturer and dealer to make financing easier. This makes it a good option if you haven’t qualified with an outside lender.

But dealer financing may also be the best option if you’re looking to take advantage of incentives on loans and leases. These are extremely difficult to qualify for, but if you do, you can drive away with a steal by using the dealer’s captive finance company instead of a bank or credit union.

Alternatives to dealer financing

If dealer financing doesn’t quite work for you or you would like to explore other options, consider these alternatives:

  • Traditional bank: Banks generally offer competitive terms on auto financing to consumers with excellent credit. A lower credit score doesn’t mean you will automatically be denied a loan, but the borrowing costs will likely be substantially higher.
  • Credit union: Auto loans from credit unions generally come with lower interest rates than you’ll find with traditional banks, and the lending criteria is a bit more flexible. However, you will need to be a member of the credit union you are seeking a loan from to apply.
  • Online lender: You can shop for the best deal on an auto loan from the comfort of your home. It’s easier to compare your options, and you will likely get a much better deal than you would financing through a dealership.

The bottom line

At the end of the day, dealership financing isn’t the worst option. However, you should already have financing from a bank or other lender before you fill out a credit application at the dealership. This gives you more room to negotiate your auto loan.

If you don’t qualify for outside financing, dealerships may be able to set you up with a loan. Just understand the costs, pick an affordable car and calculate your monthly payment to ensure you won’t be strapped for cash.

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