How Car Dealership Financing Works and Why You Should Consider It

Consumers who have done their homework in advance of buying a car know that if they need to finance the new or used vehicle, it is best to arrive at the dealership with a loan arranged in advance of the purchase. By doing so, the consumer has already determined what his or her credit rating is, has qualified for a loan at an acceptable interest rate, and knows what he or she can afford in terms of purchase price and a monthly payment. Having financing arranged in advance also encourages the dealer to come to the bargaining table with their best financing offer, saving both parties time and possible frustration.

Nevertheless, prepared consumers should always investigate alternative financing through the dealership. Car dealers have access to a broader array of financing institutions and options than the typical car buyer does, and it is possible the car dealer may find the consumer a loan with a lower interest rate and a lower payment.

The reason the car dealer wants to assist consumers in this manner is because the financial institution will give the dealer a small percentage of the interest charged for the loan, which means the dealer earns additional profit on the sale of the vehicle. For example, if a consumer is able to obtain a pre-arranged 60-month loan at an interest rate of 4% APR (Annual Percentage Rate), the car dealer might be able to get the buyer an identical loan at 3.75% APR. This is a good deal for the consumer, as it lowers the monthly car payment. At the same time, this is a good deal for the car dealer, as the financial institution may kick a quarter of a percentage point back to the dealer in exchange for bringing in the new business.

When shopping for a car loan, be sure to compare apples to apples with regard to the amount of the down payment and the number of months required to repay the loan (the term of the loan). If the car dealer or financial institution gives the consumer a lower interest rate, but requires a larger down payment or extends the term of the loan by several months, the monthly payment will be lower, but the alternative dealer financing will actually cost the consumer more money overall.

Also, keep in mind that when pre-arranging financing, the financial institution selected by a consumer will perform a credit check on the consumer as a part of the loan application and approval process. If the consumer elects to explore alternative financing through the car dealership, another credit check will be performed as a part of the process. Generally, multiple credit checks against a consumer's credit record can have a detrimental effect on the consumer's credit score. As long as the consumer has not recently applied for credit other than a car loan, a second check should not result in a credit score penalty.

Ultimately, the car dealership may not be able to find a loan that is better than the one the consumer has arranged in advance of buying a new or used vehicle. If that is the case, the consumer can rest assured that he or she obtained the best possible interest rate and terms without dealer assistance, while eliminating a potential source of car dealer gamesmanship during the purchase process.