Auto Loan vs. Dealer Financing
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If you are looking to purchase a vehicle, there are ample options to choose from. However, the vehicle may not fit your budget, or you may not have enough cash to pay upfront for it. This is when an auto loan can be of great use. But it is not the only option you have. You can also consider dealer financing if you want convenience. There is no right option here; it depends on a few factors. This guide explains the differences between the two and helps you make the right choice.
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What is an auto loan?
An auto loan is a form of financing used to purchase a vehicle, such as a car, truck, or motorcycle. It is a type of installment loan specifically designed for buying automobiles. When an individual wants to purchase a vehicle but does not have enough funds to pay for it outright, they can apply for an auto loan from a financial institution, such as a bank, credit union, or online lender. The borrower may also need to pay interest on the loan, which is the cost of borrowing money.
The loan term typically ranges from two to seven years, but it can vary depending on the lender and the borrower's preferences. The lender often considers the borrower's credit history and income when determining the loan amount and interest rate. In some cases, a down payment may be required, an upfront payment made by the borrower to reduce the loan amount.
If the borrower fails to make the required payments, the lender may have the right to repossess the vehicle as collateral to recover the outstanding debt. However, once the loan is fully repaid, the borrower becomes the sole owner of the vehicle.
Related: Best Auto Loans of 2023
Pros and cons of auto loans
Pros
- Vehicle Affordability. Auto loans make it possible for individuals to afford a vehicle by spreading the cost over a period of time. Instead of paying the full purchase price upfront, borrowers can make manageable monthly payments.
- Flexibility of Vehicle Choices. Auto loans provide the flexibility to choose from a wide range of vehicles, including new or used ones, allowing borrowers to find a vehicle that meets their preferences, needs, and budget.
- Credit Building Opportunity. Consistently making on-time loan payments can help establish or improve your credit history.
Cons
- Interest Costs. One significant disadvantage of auto loans is the interest charged on the loan amount. The interest rate can significantly increase the overall cost of the vehicle, especially if you have a high-interest rate or a longer loan term.
- Depreciation. Vehicles generally depreciate over time, meaning their value decreases. Depending on the loan terms and the rate of depreciation, borrowers may owe more on the auto loan than the vehicle's worth, which can be a concern if they need to sell or trade-in the vehicle before the loan is fully repaid.
- Risk of Negative Equity. Negative equity occurs when the amount owed on the loan exceeds the value of the vehicle. This can happen if the borrower takes on a longer loan term, makes a small down payment, or purchases a vehicle that depreciates quickly.
- Repossession Risk. Failure to make timely loan payments can result in the lender repossessing the vehicle as collateral. If you default on the loan, you not only lose the vehicle but also face negative consequences on your credit history.
Use Quicken Loans to Get a Personal Loan
- If you're tight on cash right now, you may want to consider getting a personal loan. A personal loan is a loan that you can use for just about any purpose like: paying off other debt, renovating your home, or family needs like a wedding or adoption.
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What is dealer financing?
Dealer financing, also known as dealership financing or car dealership financing, refers to a financing option offered by car dealerships to their customers. It is a form of auto loan where the dealership acts as the lender or intermediary between the buyer and a financial institution.
In dealer financing, the car dealership works with various financial institutions, such as banks, credit unions, or automaker-affiliated financing companies, to provide financing options to customers purchasing vehicles from their inventory. The dealership assists the buyer in obtaining the loan and handles the loan application process. You visit a car dealership and choose a vehicle from their inventory that you intend to purchase. Instead of directly applying for a loan from a bank or lender, you complete a loan application with the dealership's financing department.
The dealership submits your loan application to multiple financial institutions they have partnered with. If one or more financial institutions approve your loan application, the dealership will present you with the loan options. If you agree to the terms presented by the dealership, you sign a financing agreement outlining the loan terms, repayment schedule, and other conditions. With the financing secured, you finalize the vehicle purchase from the dealership. Dealer financing can provide convenience and a streamlined process for obtaining financing, as the dealership handles most of the paperwork and negotiation with lenders on your behalf.
Pros and cons of dealer financing
Pros
- Convenience. Dealer financing offers convenience as the dealership handles most of the paperwork and coordination with lenders on your behalf. You can complete the financing process directly at the dealership when purchasing the vehicle, saving you time and effort.
- Special Offers and Incentives. Car dealerships often have special financing offers or incentives, such as low-interest rates, cashback deals, or manufacturer promotions. These exclusive offers may provide favorable financing terms that are not available through other lenders.
- Simplified Process. When using dealer financing, the dealership serves as an intermediary between you and the financial institution. They take care of the loan application process, communication with lenders, and paperwork, streamlining the process and making it more straightforward for you.
- Access to Multiple Lenders. Car dealerships typically work with multiple financial institutions, giving you access to a range of loan options. They can present you with different loan offers from various lenders, allowing you to compare and choose the one that best suits your needs.
Cons
- Potentially Higher Interest Rates. The interest rates offered may be higher compared to obtaining a loan directly from a bank or credit union. Dealerships sometimes mark up the interest rate to earn a profit.
- Limited Negotiating Power. When using dealer financing, the negotiation often revolves around the price of the vehicle rather than the loan terms themselves. While you may negotiate the vehicle price, the loan terms and interest rates may be less flexible, as they are primarily determined by the financial institutions the dealership works with.
- Transparency of Terms. Dealer financing can sometimes lack transparency in terms of interest rates, fees, and loan terms. The loan terms may be presented as a package deal, making it harder to identify and compare the specific details.
Use Quicken Loans to Get a Personal Loan
- If you're tight on cash right now, you may want to consider getting a personal loan. A personal loan is a loan that you can use for just about any purpose like: paying off other debt, renovating your home, or family needs like a wedding or adoption.
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Key differences
Source of financing
Auto loans are obtained directly from banks, credit unions, or online lenders, while dealer financing involves the car dealership acting as an intermediary between the buyer and a financial institution. The dealership facilitates the loan application and works with various lenders to secure financing on behalf of the buyer.
Loan options
Auto loans provide a wider range of options since you can shop around and compare loan offers from different lenders. With dealer financing, you typically have access to a limited number of lenders with which the dealership has partnerships, which can restrict your choices.
Negotiation
When obtaining an auto loan, you can negotiate the loan terms directly with the lender, such as the interest rate or loan term. In dealer financing, the negotiation primarily revolves around the price of the vehicle rather than the loan terms themselves.
Convenience
Dealer financing offers convenience as the dealership handles most of the paperwork and coordination with lenders, streamlining the process for the buyer. On the other hand, obtaining an auto loan independently requires more effort on the buyer's part to research and apply for loans.
Transparency
Auto loans tend to provide more upfront transparency regarding interest rates, fees, and loan terms. Dealer financing may negotiate and present the terms as a package, making it harder to identify the specific details and compare them to other financing options.
Interest rates
While interest rates for both auto loans and dealer financing depend on factors like credit history and market conditions, it's worth noting that dealer financing may sometimes have slightly higher interest rates compared to direct auto loans. This is because the dealership may mark up the interest rate to earn a profit for facilitating the financing.
Flexibility
Auto loans generally offer more flexibility in terms of loan terms and options. You can choose from various lenders and customize the loan to suit your needs. On the other hand, dealer financing may have more limited options and less flexibility in tailoring the loan to your preferences.
Related: Best Auto Repair Loans
When should you apply for an auto loan?
An auto loan can be better than dealer financing in certain situations. Use our auto loan calculator before you start to shop.
Here are some scenarios where opting for an auto loan might be more advantageous:
- Lower interest rates. If you can secure a lower interest rate on an auto loan from a bank, credit union, or online lender compared to the rates offered by the dealership, it can result in significant savings over the life of the loan. It's a good idea to shop around and compare rates before deciding.
- Negotiating power. When you obtain financing through a dealership, they act as a middleman and may mark the interest rate to make a profit. However, by arranging your own auto loan, you have more negotiating power when it comes to the purchase price of the vehicle. You can focus solely on negotiating the price without the added complexity of financing.
- Flexibility. Dealer financing options often come with specific terms and conditions that may not suit your needs. With an auto loan, you can choose the loan term, down payment, and monthly payment amount that works best for your financial situation.
- Credit considerations. If you have a strong credit history, you may qualify for better interest rates and loan terms from external lenders. On the other hand, if you have a poor credit score, the dealership might be your best option as they may have relationships with lenders who specialize in providing loans to individuals with less-than-perfect credit.
- Pre-approval advantage. Getting pre-approved for an auto loan before visiting the dealership gives you a clear idea of your budget and spending limit. It allows you to focus on finding the right vehicle within your price range and avoids the potential pressure of being swayed by the dealership's financing offers.
When should you apply for dealer financing?
Dealer financing can be better than auto loans in certain circumstances. Here are some scenarios where opting for dealer financing might be more advantageous:
- Special promotions and incentives. To attract buyers, dealerships often offer promotional financing deals, such as 0% APR (annual percentage rate) or low-interest financing options. These special offers can sometimes be more favorable than those from external lenders.
- Convenience and time-saving. Dealer financing can be a more convenient option since you can handle both the vehicle purchase and financing process in one place. If you're pressed for time or prefer a streamlined experience, dealer financing can save you the hassle of shopping for an auto loan separately.
- Manufacturer-backed financing. Some dealerships offer manufacturer-backed financing programs that come with additional benefits. These benefits may include extended warranties, discounted maintenance services, or other perks that can enhance the value of your purchase.
- Limited credit history or lower credit score. If you have a limited credit history or a lower credit score, obtaining financing through a dealership may be more accessible than securing an auto loan from external lenders. Dealerships often have relationships with multiple lenders, including those who specialize in working with individuals with less-than-perfect credit.
- Flexibility in negotiation. While dealer financing may not always offer the lowest interest rates, it can provide leverage for negotiation. Dealerships might be more willing to negotiate the vehicle's price if they can make a profit through the financing terms.
Which is quicker? An auto loan or dealer financing?
If time is an issue, dealer financing will be an ideal choice because the dealers already have partnerships with financial institutions and they can speed up the process for you. They will also handle the paperwork for you.
Can I refinance my car loan?
Several lenders will allow you to refinance the car loan but not all do. You need to check with the lender you want to work with. Lenders will not allow you to refinance if the car is in a very poor condition or you have very few payments remaining on the loan.
Can I apply for a personal loan to buy a car?
A personal loan can be used for several purposes including the purchase of a car but a car loan is a specific loan only suitable for car purchase and it is backed by your car as a security.
Use Quicken Loans to Get a Personal Loan
- If you're tight on cash right now, you may want to consider getting a personal loan. A personal loan is a loan that you can use for just about any purpose like: paying off other debt, renovating your home, or family needs like a wedding or adoption.
- TrustPilot Rating 4.6 out of 5
- Connect with lenders for $0
- 100% online experience.
The bottom line
There is no right or wrong when choosing between auto loans and dealer financing. However, you must educate yourself about both options and prepare financially. Check your credit score to see where you stand, and the loan options. Try saving for a down payment. The higher your down payment, the lower your loan amount. Irrespective of what you choose, read the fine print thoroughly to make sure that you are aware of the terms.
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