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Updated on Friday, June 28, 2019
You shouldn’t avoid financing a car through a dealership so much as you should avoid only applying through a dealership. Dealers often have the opportunity to make a profit by increasing the annual percentage rate (APR) on customers’ auto loans. But they also have relationships with multiple lenders and car manufacturers. One application at the dealership means you could receive many options, including manufacturer incentives. In other words, don’t count out the dealer — instead, use the dealership finance office to your advantage. Here’s how.
How financing through a dealership works
When you submit an auto loan application form at a dealership, the dealer sends your application to finance companies it partners with, typically large lenders and local credit unions. The lenders send responses back to the dealership where a finance manager views them and presents the auto loan options to you. The thing is, as the middleman, the dealer likely will present the best option for them, not you.
For example, imagine Lender A offers a 4% APR and Lender B offers a 5% APR. These are the “buy rates,” the minimum APRs the lenders would charge you for the car you want. As a reward for sending them business, Lender A offers a small “flat” or finder’s fee to the dealer. But Lender B allows the dealer to increase the APR up to a 7% “contract rate.” That’s the rate the dealer would present to you. If you agree to the 7% APR contract rate, the 2% difference, or points, would go into the dealer’s pocket.
How dealers get paid by lenders
The example above shows how dealers are compensated for handling the financing. Lenders might give dealerships either a “flat” or allow “points.” We explain them in more detail below:
Flats: A flat fee given to a dealer, usually based on a tiered system. For example, if your auto loan is $10,000 or less, the lender might pay the dealer $50. If your loan is between $10,000 and $20,000, the lender might pay the dealer $100 and so on.
Points: The difference between the buy rate and contract rate. The number of points is how much a dealer may mark up your auto loan APR. The buy rate is the minimum APR you need to pay for the loan — it’s what the lender will charge. The contract rate is the maximum possible APR the lender will allow the dealer to charge. The difference between the buy rate and the contract rate is the profit the dealer can make from marking up your APR.
How to know what auto loan terms you deserve
The best way to avoid a dealership markup is to know whether you deserve a lower APR. In order to do this, you should either get a preapproved auto loan or an auto loan offer directly from a few lenders of your choice before you go to buy a car at a dealership. If you’re ready to look at financing, here are the best auto loans in 2019.
What is an auto loan preapproval?
An auto loan preapproval is typically a firm offer by a lender to a specific person (or people if you have a cosigner) for a certain amount of money. To apply, you should know approximately how much you want to borrow, for how long and whether you want a new or used car. You do not need to know the exact car or the exact amount. Auto loan preapprovals usually last 30 days. If you decide you don’t want to take the offer, you don’t have to do anything — it will expire on its own.
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The lender will do a hard credit pull if you apply for a preapproval, just as they would when you officially apply for a loan. This means once you do decide on a vehicle, the final terms you receive from the lender should look the same or very similar to the preapproval, depending on the vehicle you choose. A prequalification only needs a soft pull and is thus considered a “soft offer”; the auto loan terms could be very different once you do a full auto loan application.
Will applying to multiple lenders hurt my credit score?
If you do all applications within a 14-day window, applying to as many lenders as you want will not hurt your credit score any more than applying to one lender would. Some credit scoring methods even allow a window of 45 days. This window is given by credit bureaus so that consumers can rate shop for loans without penalty.
How to use financing through a dealership to your advantage
If you use a financing offer you got directly from a lender to buy a car rather than through a dealer, the dealer isn’t going to make any money off your auto loan. While it may feel nice to “stick it to the man” and not allow the dealership to run your credit, you could use the dealer’s desire to make money to your advantage.
Allow the dealer to send your auto loan application to its lender network and see what offers you get. If the dealer comes back with Lender B’s 7% APR loan from our earlier example, you might be able to whip out the offer you have in your back pocket and say, “Lender C already approved me for a 5% APR loan. Can you beat that?”
Forced with the choice of making no profit versus a little profit, the dealer might then “suddenly discover” that Lender A offered you a 4% APR.
For more tips and tricks, plus advice on what not to do at the dealership, you could read the three most common car loan mistakes people make.
Is there any situation where you wouldn’t want to finance through a dealer?
A reason you may not want to take a finance offer you got through a dealership, even if it is lower than your own preapproved offer, is if you have a lender preference. Maybe the lender with the lower APR offer you got through the dealership has a reputation for bad customer service or doesn’t have local branches and you prefer to make your car payments in person. You might even prefer the convenience of having your auto loan at the same place where you bank.
What is dealership in-house financing?
In-house financing at a dealership is when the dealer is also the lender. It is usually only offered to customers who cannot get a loan from other lenders due to bad credit or no credit and the APRs offered are often at the maximum allowed by state law. You could more on how to get an auto loan with bad credit or no credit.
Steps for buying a car
It’s a best practice to get a car before you really need one. if you need to buy a car within a day, you’ll probably feel a lot of pressure and might decide to take the first deal that comes along. Start the car buying process about a month before you know you’ll need one, if possible.
- Figure out how much car you can afford. It’s important to do this first so you don’t spend hours researching and fall in love with a vehicle only to find out it’s about $100 a month too much. Cars are more expensive than their sticker price as you will have to add taxes, fees and auto insurance into your budget.
- Do your research. Before you do any type of auto loan application, you should know in general what type of auto loan you want (used or new) and approximately how much you want to borrow for how long.
- Get a preapproval or an offer. Potential lenders could include your credit union, bank or an online lender.
- Decide on a car and negotiate the car price. The price for the car you want to buy shouldn’t be more than what industry guides such as NADA and Kelley Blue Book says it’s worth.
- Negotiate a trade-in price separately. If you have a trade-in vehicle, negotiate the price of that. Similarly, the dealership should not pay you any less for it than what an industry guide says it’s worth.
- Talk finance after all prices are set. Allow the dealership to put your loan application out to their partner lenders. Ask the dealer to beat the loan offer you already received.
- Finish the paperwork. Follow through with any paperwork such as documents you may need to provide to the lender and the dealership finance manager.
The bottom line
It is fine to finance your car through a dealership. It might not be fine to only apply for financing through the dealership. Dealers are often able to make money from auto loans in two ways: a flat fee as a reward for business referral and by marking up your APR. By knowing what you qualify for before you go to a dealership, you can avoid paying more than you have to for your auto loan.