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In May of 2017, 107 million Americans had auto loans. To put that number in perspective, that’s around 43 percent of adults in the United States. That’s a huge growth from 2012 when only 80 million people had auto loans in the United States.
While most people manage to stay current on their car payments, not everyone is that lucky. Six million people are a minimum of 90 days behind on their payments. They could end up having their vehicles repossessed.
These numbers might be frightening, but consumers looking to buy a car shouldn’t be discouraged. They can find favorable options as long as they do their homework. That begins by determining whether it is better to finance through a dealer or bank. These options might appear to be the same on the surface, but they are actually quite different.
Dealer Financing – The Good, the Bad, and the Ugly
Dealer financing is also referred to as “buy here, pay here.” These dealerships offer financing in-house so customers do not have to find an outside loan. This is different from dealerships that find outside loans for borrowers. In this case, the dealer extends credit to the buyer.
“Buy here, pay here” dealerships often provide loans to people who can’t get them from traditional banks. While some provide those loans at relatively high rates, others are reasonable, especially when considering the risk for subprime and deep subprime loans. In fact, many offer loans at 20 percent interest, which isn’t that far above the market rate for subprime and deep subprime loans.
It’s worth noting that even a dealer rate can be high with “buy here, pay here” dealerships, the clientele typically remains current on loans. In a “Buy Here, Pay Here” Industry Benchmarks/Trends 2016 report, it was reported that 82.10 percent of loans are current. Only 0.70 of the loans were 90 or more days past due. Those numbers are pretty good considering many of the borrowers are in the subprime or deep subprime categories, meaning they’re more likely to default when compared to other borrowers.
Getting a Dealer-Financed Loan
Getting a dealer-financed loan is a bit different than getting a bank loan. Since these dealers don’t rely as much on credit, consumers must have proof of income in the form of current pay stubs. Dealers also often require a proof of address along with some references.
The staff at the dealership will often talk to people about their budgets and their ability to repay the loan. They will also ask borrowers about certain credit issues they’ve had. They’re more willing to listen to someone’s story before making a decision. People are typically more than just a credit score at these dealerships.
Bank Financing – What You Need to Know
Consumers can get an auto loan through a bank in one of two ways. First, they can go to their own bank. Second, they can get a bank loan through the dealership. The dealership will send their information out to various banks, and the consumer will then be able to select a loan.
Let’s look at both options.
Getting Financing Through the Bank
Borrowers often get the best rates by securing financing from their own banks. The process works differently with different institutions, but everyone begins by applying for the loan online or in person.
Some banks provide pre-approval authorization. This lets borrowers and dealerships know how much the person is eligible to borrow. Others actually provide people with the funds. Then, they write the dealership a check for the price of the vehicle. The bank then formalizes the loan, and the borrower begins making monthly or bi-monthly payments. Customers can get excellent rates this way, especially those with the best credit scores.
Getting a Bank Loan Through the Dealership
Consumers who don’t want to use their own bank have the option of letting the dealership arrange financing for them. The dealership isn’t actually offering the financing. Instead, it reaches out to banks on behalf of the consumer. It typically has relationships with a variety of banks. Some of those banks only offer loans to people with stellar credit, while some extend financing to people with less-than-perfect credit.
Dealerships don’t do this out of the goodness of their own hearts or just to move vehicles. They do it for the kickback. The kickback is referred to as the dealer reserve, and it can add two to four points to the interest rate.
That means someone with excellent credit might end up paying five percent interest instead of three percent. That can add up to lots of extra money over the course of the loan.
Many people don’t realize they’re paying a kickback when they go through the dealership. They don’t realize the dealer has marked up the interest. They could end up with a much better rate if they went to the bank directly.
Which is Right for You?
When determining the right choice, it’s good to start with a credit assessment. People who have good credit should go with a bank. They will pay less in interest, and that means they will pay less for the car in general.
They shouldn’t let the dealership find the bank for them though. They should go to their own bank or do their own comparison shopping. That way, they won’t have to pay the dealer reserve fee for the loan. They’ll save quite a bit of money if they avoid that fee.
Those who have bad credit but need a vehicle can benefit from “buy here, pay here” dealerships. However, they need to be mindful of the cost of interest. They should shop around and find a relatively fair interest rate they can afford.