Indirect Auto Financing: A Complete Guide

Indirect auto financing is when a car dealership arranges a car loan for you through their network of lenders. Instead of getting pre-approved for financing from your bank or credit union, you rely on the dealer to find you a loan. This approach comes with some pros and cons to weigh.

What Is Indirect Auto Financing?

With indirect auto financing, the dealership serves as a middleman between you and the lender. Here’s how it works:

1. You visit the dealership and pick out the car you want.
2. The dealership collects your personal and financial information and submits it to various lenders they work with to see if you qualify for financing.
3. When you’re approved, the dealership presents you with the loan terms from the lender. This loan gets assigned to the dealer instead of directly to you.
4. You agree to the loan terms and make payments to the lender. The title gets held by the lender as collateral until you pay off the loan.

Essentially, the dealer facilitates the lending relationship but doesn’t actually provide the loan themselves. The third-party lender assumes all the lending risk.

Pros of Indirect Auto Financing

There are some advantages to financing your car through the dealer:

Convenience

The biggest pro is convenience. With indirect financing, you can search inventory, test drive, negotiate pricing, and secure financing all in one place. There’s no need to shop around for a car loan beforehand. The dealer does all the legwork of lining up financing options for you.

Potentially Faster Approval

Because dealers have relationships with many lenders, they may be able to get you approved for a loan more quickly than if you were to apply by yourself at a bank or credit union. This can save time if you need a car right away.

Bad Credit Loan Options

Specialty lenders that work with dealerships often provide loans to borrowers with poor credit. If you have bad credit, indirect financing may increase your chances of getting approved.

Add-Ons and Perks

Some lenders offered through the dealership provide additional perks with the auto loan, like extended warranties, maintenance packages, or rebates.

READ ALSO: Auto Insurance Rates By State in 2023: A Comprehensive Analysis

Cons of Indirect Auto Financing

However, there are also some potential downsides with indirect lending to consider:

Higher Interest Rates

One of the biggest cons is that interest rates are usually higher with indirect auto financing compared to direct financing you arrange yourself. The dealer likely marks up the rate and takes a cut of the interest as payment from the lender for facilitating the deal. So you’ll end up paying more interest over the life of the loan.

Prepayment Penalties

Some indirect loans have prepayment penalties if you pay off the balance early. Make sure to ask the dealer if the loans they offer have these kinds of charges.

Fewer Loan Options

When a dealer shops your application around, you only get presented with loans from their network of lenders. If you were to get pre-approved directly through lenders like banks, credit unions, or online lenders before going to the dealer, you’d likely have more loan options to choose from to compare rates and terms.

Pressure Tactics

High-pressure sales tactics are commonplace at dealerships. Pushy finance managers may pressure you into accepting loan terms that aren’t in your best interest. It helps to have financing already lined up before you negotiate with the dealer so you have more leverage and don’t make a rash decision.

What Credit Score Is Needed?

The minimum credit score needed for indirect auto financing varies by lender but is generally around 600. Some subprime lenders that specialize in bad credit may approve scores in the 500s, but the interest rate will be much higher. The better your credit, the more favorable loan terms you can qualify for.

Will I Get the Best Rate?

In most cases, no. Indirect lending usually means paying a higher interest rate than you would through direct financing channels. That said, dealers work with “buy rate” lenders that offer below-market rates to competitive applicants with good credit (generally above 700). So if you have excellent credit, negotiating the buy rate through the dealer can snag you the best rate. But more often than not, buyers end up paying more interest when financing through the dealership.

Can I Get Pre-Approved for Indirect Financing?

No. With indirect lending, the dealer initiates the application process and facilitating financing on your behalf. The only way to get “pre-approved” is to apply directly with banks, credit unions, or online lenders before visiting dealers to car shop. Then you’d have a direct loan pre-approval in hand with set terms when you negotiate with the dealer.

What Fees Are Involved?

When financing through a dealer, expect to pay some type of fee to the lender and/or dealer. Here are some common fees:

• Origination fee – A flat upfront fee charged by the lender to process the loan, usually around 1% of the loan amount
• Documentation fee – The dealer’s fee for preparing your loan documents, averaging $300-$500
• Finance reserve (dealer reserve) – The dealer’s cut of the interest paid to them by the lender, often 1-2% of the loan amount
• Administrative fees – Miscellaneous fees for administrative tasks

Always verify complete fee breakdowns before signing anything. Reputable dealers will disclose all fees upfront. Predatory dealers tend to lowball estimates and surprise you with added fees at signing.

How Do Monthly Payments Work?

As with most auto loans, indirect financing requires making monthly payments to the lender to pay down the principal balance and interest. Payment amounts vary based on factors like:

• Loan amount
• Interest rate
• Loan term length (number of months) A $25,000 loan at 6% interest over 5 years would have a monthly payment around $470. Payments usually start 1 month after getting the loan. Make sure your budget comfortably accommodates the monthly payment before committing to any auto financing.

READ ALSO: Auto Loan Types: Purchase, Refinance and More

Can I Get Gap Insurance?

Gap insurance covers the gap between what your car insurance pays if your vehicle gets totaled and what you still owe on the loan. This protects you from owing money on a car you no longer have. Many lenders in dealers’ networks offer gap insurance policies you can add to the loan, either as an option you pay for upfront or that gets wrapped into the loan amount. Gap insurance is not required but can provide peace of mind.

What Happens If I Miss a Payment?

Failing to make payments has serious consequences with indirect auto financing just as with direct loans. If you miss payments, you risk:

• Late fees – Lenders charge fees for late payments, around $15-$40 per incident.
• Interest charges – Interest keeps accruing on unpaid balances.
• Credit damage – Missed payments get reported to credit bureaus, negatively impacting your credit score.
• Repossession – Default on too many payments, and the lender can legally take back the car.

Missing one or two payments won’t necessarily lead to repossession right away. But repeated delinquency makes it likely. Communicate with your lender if you anticipate having trouble making payments to discuss alternative options before things spiral.

Can I Refinance My Loan Later?

Yes, you can refinance an indirect auto loan later on, either through the dealership or a direct lender. Refinancing makes sense if your credit improves significantly or if market interest rates drop. You’ll go through a similar application process for the new loan, which pays off and replaces the existing one.

Just beware of refinancing too early into your original loan term, as you may incur fees and wind up paying more overall interest expenses over a longer period. For the best savings, wait at least 12-18 months before attempting to refinance.

What Happens at the End of the Loan Term?

Provided you make consistent monthly payments as agreed over the full loan term, at the end:

• The loan balance reaches $0
• You’ve paid all principal, interest, and fees owed
• The lender releases the lien and car title to you
• You fully own the car free and clear

There are usually no extra steps required when you pay off an indirect loan. The lender handles discharging the lien automatically once paid in full. Congrats – that car now belongs only to you!

To Recap

Indirect auto financing provides a convenient one-stop shop to purchase and finance a car through the dealership but often comes with higher rates and fewer options compared to direct lending sources. Weigh the pros and cons carefully based on your budget, credit, and financial priorities to decide if it’s the right choice for your needs. Whichever financing route you pick, the critical thing is shopping around beforehand, reading all terms carefully, and avoiding pressure into any deal not right for your situation.

Frequently Asked Questions

Is indirect financing the same as dealer financing?

Yes, indirect financing refers to loans arranged through the car dealership as opposed to loans you get directly from banks, credit unions, etc. So the terms “indirect auto financing” and “dealer financing” refer to the same process of the dealer facilitating an auto loan through their lender partners.

How long do I have to pay off an indirect auto loan?

Loan repayment terms typically range from 36 to 72 months, or 3 to 6 years. Longer terms mean lower monthly payments but more interest paid over the life of the loan. Aim for the shortest term you can afford for the least interest expenses.

Where do dealers get their financing from?

Dealers have relationships with various banks, finance companies, and other lending institutions to offer credit to car buyers with a range of credit. Large national banks, smaller regional banks, and specialty subprime lenders usually make up a dealership’s lending partners.

What is a “buy rate”?

The buy rate is the baseline wholesale interest rate lenders offer dealers to provide financing. Buy rates assume borrowers with good credit scores. Dealers then mark up the buy rate when presenting you with financing offers. So negotiating the buy rate can score you the best interest rate.

Can I get pre-approved through a dealership?

Not exactly – the dealer won’t pre-approve your own financing. But they can submit your application to lenders to see which ones would likely approve you before you pick out a specific car. If you have bad credit, this preliminary approval process may improve chances of ultimately getting a loan.

What loan terms should I look out for?

Scrutinize loan details for any unfavorable clauses like:

• Mandatory add-ons you don’t want
• Balloon payments tacking on extra principal at the end
• Prepayment penalties for paying off early
• Interest rate spikes after an initial teaser rate period

Avoid loans structured with these kinds of lender-friendly terms that can significantly drive up costs.

Can I use indirect financing on a used car?

Yes, indirect loans can be used to purchase both new and used vehicles. Lenders have specific policies on the maximum age and mileage limits on used cars. But dealers have relationships with lenders flexible on financing older used vehicles too.

In another related article, How to Get an Auto Loan Online: A Complete Guide