What Is An Indirect Loan In The Auto Industry?

An indirect loan, also commonly referred to as dealer financing, is a type of installment loan wherein the lender isn’t directly linked to the borrower. The lender can either be the original issuer of the loan or the present holder of the debt. 

These types of loans, which are arranged by auto dealerships, support borrowers by improving funding availability. These loans are the best fit for those applicants who often fail to meet the stricter criteria of direct loans. However, indirect loans are likely to be more expensive due to the higher accompanying interest rates.

How It Works

Oftentimes, auto dealerships build relationships with several intermediary lenders to assist their customers with financing. This gives dealerships a range of financing options to explore when attempting to arrange a loan for a buyer.

However, the presence of an intermediary, in this case, the dealership, is what makes this process different. After a car buyer submits a financing application, the dealer shares this information with the lending network to bring potential offers back to the buyer. 

These loans may not stay with the original lenders but instead, be sold off to other lenders or investors that’ll collect the approved sum. Ultimately, the new debt holder is responsible for every status of the loan. This is a critical piece of information because in certain cases, the financing agreement can be canceled. 

For instance, in the case that a dealership helps issue a loan, but is unable to turn around and sell the loan amount to another party, they may be able to cancel the loan depending on the contract conditions. 

In this unique scenario, a car buyer would have to return the vehicle. However, the buyer is entitled to their down payment or trade-in vehicle if it was a part of the original purchase arrangement. While a dealership might try and present the buyer with a new set of terms, these are likely to be worse than the original loan agreement’s terms. Buyers aren’t obligated to sign a new loan agreement, so be wary of pushy dealerships.

Direct Vs Indirect Auto Loans

Direct loans can be originated by a financial institution like a bank, credit union, or online lender,  whereas indirect auto loans are when you obtain financing through a dealership’s lender network. One benefit of a direct loan is that you can qualify for the amount both before and after finding a suitable car. Besides being able to compare different offers, it grants buyers additional leverage in purchase negotiations when they have already pre-qualified for financing offers. 

On the other hand, indirect auto loans are only provided after you’ve picked your desired car. While convenient for those buyers who wish to handle the process on the dealership premises, the rates will likely be less attractive than comparable direct loan options. However, for borrowers with weak credit scores and histories, this might be a more advantageous route than direct loans.

An Example

Indirect auto loans are chiefly associated with the secondary loan markets. After a loan is issued, it can be sold off to another lender or investor.  When these loans are packaged with a number of similar loans and sold to investors as securities, this process is known as securitization. The goal of securitization is to free up capital on lenders’ balance sheets by selling loans to investors. This free capital is then lent out to other borrowers. This is a key part of a lender’s risk management arsenal.

The mortgage-lending market is a perfect example. The Federal Home Loan Mortgage Corp (Freddie Mac) and the Federal National Mortgage Association (Fannie Mae) both support the secondary market for loans. By helping mortgage lenders move loans off their books, these lenders have access to liquidity which is then used to finance new buyers.  

The Benefits

Indirect lending has grown by leaps and bounds over the last few years within the auto financing market. Listed below are some of the notable benefits: 

• Borrowers find it more convenient as they can buy the car as well as secure financing in one location. It helps save time and effort.
• Borrowers with lower credit scores have better chances of securing subprime loans through indirect financing. 
• If you have a good credit score and choose indirect financing, you might be eligible for additional incentives like 0% APR.
• You can still access competitive rates when compared to banks and credit unions. Even if the dealer adds their commission, you can still expect a reasonable interest rate if you’re a prime borrower.

Conclusion

Obtaining indirect loans can be profitable when you do the research and compare multiple quotes to filter out the best offers. Although a credit score isn’t required, you must keep in mind that having a good rating can increase your chances of availing additional discounts and extremely low rates. Above all, bear in mind that dealerships tend to add extra charges on top of the rates offered, so it’s a good idea to negotiate the price before you sign up for the loan.