Financing A Car: Dealership or Direct Lender?
When financing a new or used car, you basically have two options: secure a loan from a private institution, called a direct lender, or go through the dealership where you find the car you want to buy. Both options have strengths and weaknesses, so keep reading to see what will be the best fit for you.
Direct Lending is essentially financing through a private company rather than a car dealership. There are several options for direct lending:
- A major bank, such as Bank of America, Wells Fargo, or Chase.
- Credit unions
- Online lenders such as LendingTree for MyAutoLoan
- Lenders specifically designed to offer loans to recent immigrants, like Stilt or International Auto Source. These can be an especially good option for immigrants without a credit history.
How Does Direct Lending Work?
First, get pre-approved. This will tell you the amount the lender would be willing to lend you based on your credit score and income information. The offer will also clearly state all the loan terms, so you can see exactly how much the loan will cost you as well as what your monthly payments will be.
Direct Lending Tip:
A pre-approval is what is referred to as a “hard credit inquiry,” meaning it will lower your credit score just a bit. However, credit agencies won’t penalize you further if you make additional auto loan inquiries within a period of 14 days, so be sure to apply for pre-approval with around 2-3 lenders within this time frame to see which can offer you the best terms.
Why Use Direct Lending?
- Allows you to shop around for the best loan terms before ever setting foot in a car dealership.
- Avoid expensive dealer add-ons
- Pre-approval tells you exactly how much you can afford, so you won’t get attached to a car only to realize it’s out of your price range.
How Does it Work?
Dealerships themselves will offer financing. After deciding on your car, the finance department will apply for offers on your behalf, usually with several lenders. After deciding on your lender, the dealership will finalize the loan for you.
Why Use Dealership Financing?
Financing with the dealership directly is certainly the most convenient: you simply have to show up, choose a car, apply for the loan, and finalize the paperwork. Additionally, many dealerships will have promotions, such as an initial 0% APR or no down payment.
Downsides of Dealership Financing
While convenient, financing with a dealership will nearly always cost you more. If you decide to go this route, watch out for the following:
- Inflated interest rates. Many dealership financing representatives won’t tell you the actual interest rate their affiliate lenders are offering. Instead, they will tell you a higher number, then pocket the difference as profit.
- Expensive add-ons. Extended warranties, gap insurance, paint insurance — you don’t need them! These are essentially just money-makers for the company. Anything you decide you want later, you can buy then.
Which Should I Choose?
The best practice would be to first get pre-approved for a loan from a direct lender and then take this offer into a dealership and ask for its offers too. This way you can leverage your direct lender rates to see if the dealership can beat this offer. At the end of the day, don’t get distracted by lower monthly payments or promotions. Compare the total cost of the loan over its full term and simply choose whichever is lowest.