What Is Car Dealer Financing?

If you want to buy a car using a loan, you have a few different options regarding where and how you get the total amount of financing that's needed. One approach is to do plenty of research to find banks that offer auto loans, get pre-approvals and sort through the pros and cons of each financing offer. The other approach is seeking car dealer financing where you handle the car loan application when you're on the vehicle lot.

With financing through the car dealer, you may get the loan directly from the dealership or indirectly through an affiliated financial institution. Since dealer financing comes with important pros and cons to consider, learn more about how this financing option works, when you'd want to pursue it and what the application process involves.

Similar to how a credit union or bank would provide you with a mortgage to buy a home, the same financial institutions, and the dealerships themselves, offer car loans that break up the price of your car into more manageable monthly payments over a span of years. Car loans usually require a down payment like many types of mortgages do. They're considered secured loans because your car is used as the collateral during the loan term. Just as you might face foreclosure if you don't pay your mortgage, lenders can take your car for nonpayment as well.

When you take out a car loan, your monthly payments include interest charges alongside the loan principal and any extras like add-ons and credit insurance. Current market rates, your creditworthiness and any markup will all impact the interest rate and thus the overall cost of your vehicle loan. In some cases, you might get a special financing deal that waives interest either permanently or for a small time window.

Since car loans are secured, the lender's name appears on your car title as you're making payments, and depending on where you live, the lender may actually have the title until payoff occurs. The title is changed to show your name after you've completed your last car payment, and you also have outright ownership of the car at that point.

When you choose to get car financing through the dealer, you can avoid working directly with a loan and credit union and instead have the car dealer serve as the intermediary or even as the direct lender in the process. While you'd probably shop around for car loans through different sources before even heading to a car lot when you're going the direct financing route, using dealer financing means you don't start your application until you're at the dealership and have already chosen a specific car to buy.

In many cases of dealer-arranged financing, you request an auto loan, and the dealership starts working with financial institutions to find loan options for you and then presents you with the terms. This can involve multiple credit pulls for each potential lender.

Once the results come back, you can have multiple loan offers with different interest rates to choose from, but these interest rates may be higher than what the financial institution really offered, since dealerships usually have the ability to mark up the rate with this type of indirect financing. Once you've agreed to the terms, you finalize the application, and you can expect to make your monthly car payments to the associated bank rather than the dealer.

Especially common at used car lots that may cater to people with poor or no credit, on-the-spot financing is another type of dealer financing where the dealership acts as the lender rather than just an intermediary between you and another financial institution. This option also differs from dealer-arranged financing in that the dealership usually determines an approved loan amount before you start shopping for a car, and interest rates tend to be much higher. You can then select a qualifying vehicle, and once you've completed the purchase, you send your monthly car payments to the dealership rather than to a financial institution.

​Read More​: How to Get a Car Loan

One of the biggest appeals of using dealer financing is the convenience for car buyers compared to shopping for loans through local credit unions and banks. While some dealerships have a car loan pre-approval form on their website so you can get a quick idea of your chances of getting approved, you can usually just show up at a dealership, look around at different vehicles and request dealer financing once you've found a car you like. This saves you time versus providing your financial information to numerous financial institutions directly, and you can still compare financing offers from the dealership.

Depending on your credit score, going with dealer financing can give you access to special financing offers that a direct car loan won't. For example, manufacturers sometimes work with dealerships to provide ​0 percent​ interest loans for specific vehicle models. Usually, you need to agree to a specific loan term to take advantage of no interest, and you can expect to need a high credit score to qualify. You might even get other perks or add-ons for using dealer financing, so it can be worth considering even if you got pre-approval from a bank already or usually would just use cash to buy a vehicle.

If you've had problems getting financing before due to a limited credit history or low credit score, you could benefit from in-house financing as long as you're aware of the higher interest rates involved. Dealers offering this kind of financing are more willing to take on a risky borrower than a regular bank or credit union would, and the option can help if you desperately need a vehicle and have run out of other options.

Often, the dealer will take advantage of a vehicle disabling device they can use in case the borrower doesn't pay and the vehicle needs to be repossessed. So, you'll want to stay on top of your payments.

While moving forward with dealer financing can make things simpler for you as a borrower, you often pay a higher interest rate than if you had sought financing yourself. If you get dealer-arranged financing, this usually is a small markup of the interest rate the bank charges since the dealership wants to get some small profit from the financing deal.

When it comes to in-house dealership financing, you could face an interest rate that could reach ​20 percent​ versus a rate of ​3 to 5 percent​ through other financing options. Keep in mind that in-house financing usually limits you to used cars as well, so there's less flexibility.

You might also feel pressure when you're working with a dealership for financing since you've often already got a car ready to purchase and a salesperson who wants to push the sale. This means you might not give yourself enough time to review the financing offers presented, and in some cases, the dealership may not take time to share them all with you. In the end, you might end up taking an unfavorable loan and end up paying too much interest. At the same time, dealing with financing at the same time as the car purchase can give you less time to try to negotiate a better price for the car.

If you're going through the application process at the specific car dealership that has your desired car, you may want to research online beforehand to look at local vehicle inventories. If you have doubts about your loan approval or amount, it helps to have a few different dealerships and vehicles in mind so you have another option to consider if something doesn't work out.

Once you've found a few vehicles you're interested in financing, you can start contacting the dealerships to get initial used or new car quotes as well as quotes for any car you plan to trade in and apply toward the vehicle purchase. You can further negotiate once you get to the car dealership lot.

Before going down to proceed with the purchase and financing processes, make sure you take care of the following qualifications for dealer financing and know what you need to bring with you on your visit to the dealership:

• ​Assess the vehicle's affordability​: If your income can't support your current living expenses and debts alongside a car payment, you'll run into issues getting dealer financing. The dealership uses your documented income plus credit report to calculate debt-to-income ratios and make sure you're not overextended, since they want reassurance that you won't default on the car loan. If your other debts plus a car payment make up ​50 percent or more​ of income, expect challenges with approval. You can use a car affordability calculator online to help calculate your potential monthly car payment and see how that fits in with your budget.

• ​Examine your credit profile​: Your credit history and credit score not only determine your auto loan approval but the cost of borrowing with interest. So, take some time to review your credit report and score and see where it falls on the scale. Usually, credit scores in the ​mid-600s and higher​ can help you get regular dealer financing, but if your score's lower than that, you may need to consider in-house financing programs that help people with poor credit but come with a higher cost of borrowing.

• ​Gather down payment funds​: Lenders may want a down payment when you apply for a car loan, especially if you don't have great credit, so it helps to have ​at least $1,000​ ready for this purpose. The more you can put down, the lower the loan amount will be, and the less interest you'll need to pay.
  

• ​Consider a co-signer if needed​: If you have concerns about your credit and income, consider asking someone you know to be your co-signer so that their credit score and income are considered in the loan approval. Since you're asking someone to risk their credit to help you, consider this option carefully, and if you proceed, pay your car loan responsibly.
  

• ​Bring important documents​: While dealerships may ask for more documentation, expect to at least need to show identification and proof of income, like a tax return or check stub. In-house financing programs may require personal references and documents showing residency. Your current car's title will be needed for a trade-in as well.
  

​Read More​: What Is a Prime Credit Score for an Auto Loan?

When you're at the dealership to start your financing application, you answer basic personal and contact information questions, provide information about your income sources and other obligations like rent or mortgage payments, discuss preferences for your loan terms and payment amount, and present the requested documentation. If you have a co-signer, they need to be present and answer personal and financial questions and provide documentation as well. The dealer also takes down information about a down payment or trade-in since these impact the loan amount you're requesting.

In the same way you can negotiate your car's price before you apply for financing, you can negotiate with the dealership once they run your application and present you with loan terms. You can try asking for a lower interest rate, rebates or free add-ons like an extended warranty that can make it a better deal. Once you're happy with the deal, you can move forward with signing the papers to get your new car and finalize the loan.

​Read More​: How to Negotiate a Car Price

After you've secured a vehicle with dealer financing, find out to whom you should make your car payments and always make them on time to avoid negative financial consequences for yourself and any co-signer. You may have the option to defer a monthly payment if an emergency happens, but this could come with a fee.