Be Careful When Arranging Financing Through a DealershipA typical car dealership has relationships with about 20 different lenders, some of which only lend to prime borrowers while others specialize in sub-prime. These can include banks, independent finance companies, and even credit unions.
Many of these lenders only make indirect loans, meaning a car buyer cannot deal directly with them. These loans can only be arranged through a dealership so it's always a good idea to include them when comparison shopping your loan, however you need to be aware of an inherent conflict of interest.
In exchange for setting up the loan, many lenders allow the dealers to markup the interest rate and make a profit on the difference. This is called a finance reserve and although most lenders cap the markup to a maximum of 2.5%, there are some that allow dealers to add much more than that.
For example, a lender may approve your 60 month loan at an interest rate of 6%, but will allow the dealer to mark that up to 8% when presenting it to you. If your loan is for $15,000, that 2% difference will cost you over $1,000.
When dealers shop for financing, they submit your information to their lender network and usually get instant approvals based on your credit report and other factors.
Lenders use a rate sheet listing their interest rates, the maximum loan amounts, the markups they allow, and the fees the dealer will need to pay.
Here's an example rate sheet:
The thing you need to watch out for are dealers that will assign loans to you based on the commissions they will generate rather than the money they will save you.
A dealer may be able to get multiple approvals from several different lenders at varying rates, but they will only present to you the one that will make them the most money.
You should always ask to see the actual approvals to make sure they're presenting you with the best loan terms. The problem is, they can lie and tell you there was only one approval. This should be a red flag.
The best way to protect yourself is to shop for car financing before going to the dealership. This will give you a base rate they will have to beat in order for you to finance through them. It's a simple method that works wonders.
There are countless stories of auto loan terms magically improving when the dealer finds out the buyer arranged their own financing.
Each week, I'll keep you up-to-date on the latest car deals and news that might affect your purchase. This includes...
- Best Rebates, Incentives, and Lease Deals
- Latest Car Buying Scams and Tricks
- The Best & Worst Time to Buy a Car
- Which Cars You Should Avoid