Used Car Dealer Financing: What You Need to Know

Used Car Dealer Financing: What You Need to Know
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When you buy a used car at a dealership, there are financing options available so you don't have to do the work of finding a lender on your own. Used car dealer financing can mean either having the dealership lend you money directly or having them arrange for you to get a car loan through one of their affiliated financing companies.

While such options come with perks, such as simplicity and a potentially easier qualification process, they come with limitations when compared to traditional direct lending. Learn about the types of used car dealer financing and steps to take as you borrow for your next used car.

Basics of Used Car Financing

If you haven't saved enough for a used car purchase, financing can make it less of a financial burden to pay for the vehicle, and it can come in various forms that might fit your preferences and budget. By financing a used car, you can just pay certain upfront costs like a down payment. Depending on the loan-to-value ratio, you may be able to put fees and taxes in the loan too rather than paying for them when you get the car. Depending on the method chosen for used car financing, you can either let the dealer handle it all – which could mean in-house financing or arranged financing – or you can seek it on your own.

Your used car loan can have a term of ​up to 84 months​ depending on the loan and lender. However, the longer you spread out your vehicle's payments, the more you end up paying in the end. Your lender usually calculates simple interest over the course of the loan, and high interest rates can occur with certain used car loans.

Each month, you pay toward both interest and principal until you've finished your payment plan or arranged for an early payoff. Failure to pay your car payment can lead to fees, credit report issues and even loss of the used vehicle.

In-House Used Car Dealer Financing

A popular form of used car dealer financing – often called "buy here, pay here" financing – involves obtaining a direct loan through the dealership. Since the dealership doesn't have to negotiate with a bank or follow the bank's terms for lending, this financing method can make it easier for you to obtain a used car if you have a problem with your credit history. Often, the dealer advertises that the auto loan requires no credit check. However, they might still check customers' credit but not automatically deny someone due to past delinquencies or lack of credit record. With this type of loan, the dealership usually requires a significant down payment.

When you seek in-house financing, you usually get preapproval upfront when you visit the dealership. That way you'll know your maximum vehicle price before you begin looking at vehicles on the lot. Unlike other types of car loans that allow you to choose a new or used vehicle, this type has less flexibility since you need to choose a used car on the specific lot where you got approved for financing. These cars may cost much more than what they're worth, especially when you consider that high interest rates are common for this alternative financing option.

In-house financing stands out from other financing options due to how you make payments as well. The dealership takes your monthly car payment rather than a credit union or bank. You might also find the dealership attaches a tracking device to your car – such as the one available from Spireon – since customers who use "buy here, pay here" financing are a higher risk to dealerships. After having this kind of device installed on the car, the dealership can easily find the vehicle and repossess it if you stop making your payments.

Dealer-Arranged Used Car Financing

The other type of used car dealer financing – called dealer-arranged financing – has the dealership serve as a helper with obtaining the financing rather than the party directly loaning you the money for a car. The dealership has affiliations with certain financing companies to whom they can send a loan application for you and obtain offers that you can consider. The bank adjusts the interest rate you're offered so it can get some compensation for being a middleman. For example, a credit union might offer you a ​3.5 percent​ interest rate, but the lender can add ​1 percent​ for the fee so that you really pay ​4.5 percent​.

You've often already found a car on the lot that interests you when you apply for dealer-arranged financing. This helps since the dealership can give you an estimate of the car's price plus any add-ons as well as the down payment or trade-in that applies to the vehicle purchase. Unlike with in-house financing where you're usually limited to a used car, you can use dealer-arranged financing for new vehicles as well if you wish. This financing arrangement typically comes with a better interest rate than in-house financing and usually doesn't require the gadget that helps with repossession.

As a used car buyer, you'll find this financing method convenient since you don't have to spend time exploring lenders or applying on your own. However, dealer-arranged financing does differ in that you make the payments directly to the credit union or bank after you've closed on the deal. So, if you prefer to make payments in person, check to make sure the arranged lender has a branch near you.

The Alternative of Direct Financing

As an alternative to seeking used car financing through the in-house or dealer-arranged methods, you could find a bank or credit union that will offer you a direct auto loan without the dealer's help. You can usually visit your current financial institution's website, call them or go in person to discuss getting a car loan. This can be appealing since you're already familiar with the bank, and they have your information from other accounts. On the other hand, this used car financing method offers the opportunity to check out new banks and credit unions, submit preapproval requests and run a comparison to find who offers the best terms for your financial situation.

You can use a direct car loan for either a new or used vehicle, but each financial institution sets rules on which used cars qualify for financing, so this can take more research to get a flexible offer. For example, for Capital One, the vehicle must have ​no more than 120,000 miles​ on it and must be no older than a ​2010 model.​ They also exclude certain brands, such as Oldsmobile and Saab. Also, financial institutions may require that you buy a vehicle through a participating dealership and set a minimum vehicle value for financing.

Since there's no middleman, you can benefit from lower interest rates with direct vehicle financing as long as you feel comfortable negotiating with the bank and handling the entire application process on your own. You need to start the application process before you get to the dealership so that you're prepared with a document showing preapproved financing. You can expect to complete additional steps once you've selected a used vehicle to finance. Like with dealer-arranged financing, you send your monthly payment directly to the lender.

Dealer Financing Pros and Drawbacks

Reasons to consider moving forward with one of the types of used car dealer financing include the convenience versus direct lending and the opportunity to get a used car quickly when you need it. You have the dealership helping with the whole application process, and you have less research to do with lenders. Not only can you get a car loan quickly with dealer financing, but you can have an easier time getting qualified in the first place, especially if you use in-house financing.

On the other hand, beware that these perks may be outweighed by the higher costs. Not only might the used car cost more than what you could pay if you bought privately, but used car loans have less competitive interest rates, and some can even have rates several times that of a new car through direct lending. Therefore, you can find yourself in a situation where your used car has less value than what your loan balance looks like. Negative equity can cause trouble if you want to trade in the car eventually, since you'd be stuck with a remaining balance on the loan.

Used Car Dealer Financing Requirements

Whether you want in-house or dealer-arranged used car financing, there are similar requirements in that you need to have sufficient income for the car payment and probably a down payment. You also need to present documents proving your pay and residency along with some personal references in certain cases. However, some extra requirements – such as your credit score – apply depending on the type of dealership loan you want.

For example, Auffenberg Dealer Group requires that you make at least ​$1,500 to $2,000​ a month and present a ​10 percent​ down payment if you want in-house financing. They will accept a bad credit score as long as they see you can afford the used car payment, but they do need you to provide references and proof of your income.

On the other hand, if you were seeking dealer-arranged financing somewhere, you'd likely need a credit score in the fair-to-good range – preferably in the ​700s​ – for lower interest rates, but there may be more flexibility with a down payment. Dealer-arranged financing might not involve a specific income limit, but look at your debts and income to decide what's affordable in terms of debt-to-income ratios.

Finding Used Car Dealer Financing

Since used car dealer financing gets tied to a vehicle at that dealership, it's wise to start your journey at a place that has vehicles that appeal to you. You can visit used car dealership websites to see the inventory and check out their financing options and preapproval applications. That way, you know whether you qualify for a suitable vehicle before you make the trip to see and test drive cars.

Before going to the used car dealership, you can begin the negotiation process from home to save time. On the website, you might find a button to inquire about a specific used car or a number to call to speak with a salesperson. Work on negotiating the price down on the used car and try to talk to a few different dealerships so you don't get stuck taking a bad deal.

During this process, also ask questions about the car's condition, check the pictures, get a vehicle history report and prepare to do an inspection and test drive before you agree to move forward with the purchase. It's also helpful to get a warranty.

Read More​: Used Car Buyer's Checklist

What to Expect at the Dealership

Along with choosing a vehicle at the dealership, you can expect to handle the application process and negotiate the terms of your loan. Specifically, you need to provide personal and financial information to the dealership regardless of the type of dealer financing you seek, and you must provide them with documentation, such as pay stubs, references and proof of your address. Decide what amount of money you can put toward the loan, and whether you want to trade in your old car for credit toward the new one.

After the car dealer runs your information and has a loan offer, consider the loan term and try to negotiate your interest rate. If you want to minimize interest charges, aim for the shortest-term loan, even though this raises your monthly payment.

Keep in mind that negotiating a good interest rate can be harder when you're seeking in-house financing since lenders charge more for the high risk they take on. On the other hand, you should have access to multiple loan offers if you're seeking dealer-arranged financing, and you can choose the cheaper offer and negotiate to see if they'll lower the interest rate that comes from the dealer-bank arrangement.