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Tips & Advice: Direct Loans vs. Dealer Lending

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Despite being a chore, buying a car is also exciting. So exciting, in fact, that we often don't take the time to think about the financing until we've chosen the exact car, settled on the purchase price and are sitting across the desk from the dealership's business manager. That's an oh-nuts moment for many a car buyer. Don't be one of them -- all the hard work of negotiating a good price on your next car could be erased by making the wrong choice among all the car loans available.

Walking into a new- or used-car dealership without having a well-thought-out plan for financing the car you're going to buy is like taking a flying leap without first checking out your landing spot. You might just luck out and land on a pile of pillows, but more likely, you'll be jumping headfirst into a sea of broken glass.

There are as many car loans as there are lenders, and it only makes sense to secure the best terms available to you based on your credit history and your budget. These two factors are a discussion for another time -- we'll assume you've already researched your credit history and score and done the math on how much car you can actually afford. Here, let's consider the pros and cons of direct loans versus dealer-arranged lending.

1, 2, 3 of Car Loans

If you don't pay cash for your next car purchase, you'll need to borrow the money -- and unless you have a well-heeled uncle to tap for the cash, that means securing a loan through a commercial lender. When buying a new or used car from a dealer, there are two avenues for financing the purchase: You can arrange a loan directly from a bank, a credit union or a loan company, or the dealership business manager can reach out to one of the many lenders with which the dealership has a relationship and arrange the loan for you. That's the difference between a direct loan and dealer-arranged lending.

Direct Loan

Shopping around for a lender before entering the dealership puts you in the driver's seat. Even if you decide to allow the dealer to arrange your financing, you should still approach a couple of lenders directly to establish a benchmark for the best interest rate you qualify for. Begin with any financial institution that provides car loans and that you already have a good relationship with. They already know you and will often respond in hours rather than days. Then, check out some other lenders. Even if you don't belong to a credit union, they'll often quote rates to nonmembers. If the deal is good enough, it might be worth your while to join.

Many commercial lenders will prequalify applicants. That means you can walk into a dealership knowing exactly how much car you can buy. Being able to tell the sales person that you're guaranteed financing for a certain amount also provides a serious tool for negotiating the best purchase price.

Dealer-Arranged Lending

Although you may feel you're too busy or -- dare I say it -- too lazy to do the research before entering the dealership, let's be honest -- these aren't good reasons for not arranging your own financing. There are really only two good reasons: You have poor credit, or you want to take advantage of special financing deals offered by the carmaker that the dealership represents.

As for the first good reason, dealers have a lot of lenders on speed dial, and they're highly motivated to secure a car loan for you. Depending on your credit history, credit score and other factors such as employment history, the dealership's business manager can call on the lenders most likely to lend to you. Some dealers even advertise loans for buyers with a poor credit history.

The second reason to arrange financing at the dealership is because only a franchised dealer can hook you up with its carmaker's advertised car-loans deal. The lending division of many carmakers, such as Ford Motor Credit or Toyota Financial Services, often offer special financing deals. It might be cut-rate, 0 percent interest or a cash-back offer. Be warned, though: Such offers almost always require bulletproof credit. Unless you know you have virtually perfect credit, you should back yourself up with a prearranged credit agreement with your own lender.

What it means to you: The best rule of thumb is always to arrange car loans directly with a lender. Even if you're going with dealer-arranged financing, you need the information that you get from doing the footwork yourself, and you aren't obligated to use the option the dealer provides.

This image is a stock photo and is not an exact representation of any vehicle offered for sale. Advertised vehicles of this model may have styling, trim levels, colors and optional equipment that differ from the stock photo.
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Tips & Advice: Direct Loans vs. Dealer Lending - Autotrader