Dealer Financing vs. Direct Lending

Understanding the Two Financing Options

Both dealer financing and direct lending will get you a car loan, but the process is typically different. In one, you take on a loan first, and then go to pick out the vehicle that meets your needs. In the other, you typically shop for a vehicle, and then see if you can get financing for the one you've found. Here's a look at the differences between dealer financing and direct lending.

What is Dealer Financing?

Dealer financing is when you go to a car dealership to purchase a vehicle, but haven't lined up any financing through your bank, credit union, or other lenders. In this case, you're relying on the dealership to have a lender or lenders that they can go through to give you financing options.

The lenders used by dealerships are called third-party lenders, and they typically work for independent financing companies. Sometimes, you also have the option of a captive lender, which is the financing arm of a specific automaker, such as Chevy or Kia. The options you encounter for financing at a dealership will depend on your credit situation, and the better your credit score is, the more options you'll typically have.

What is Direct Lending?

Direct lending is when you set up a loan through a financial provider, such as your bank or credit union, and then take that amount and shop at a dealership like a cash buyer. When you finance through a bank or credit union, you typically have the opportunity to take on a loan with a lower interest rate than if you were to get a loan through a dealership. However, bank loans typically come with strict credit requirements that may be hard for all borrowers to meet.

If you're a member in good standing at a bank or credit union, then you should try them first, as you have a better chance at a loan when you're an established customer.

Pros and Cons of Each Option

Dealer Financing: Advantages and Disadvantages

When you have poor credit, dealer financing can be a little tricky to obtain, depending on where you look. If you're only looking at high-end franchised dealerships, you may not find the options you need for bad credit financing. Bad credit options typically only appear if you're looking at a special financing dealership. There are many pros and cons to dealer financing, such as:

• Convenience: Since you're applying for financing at the dealership, you don't have to worry about going to multiple places to take care of your loan. You may also experience faster loan decisions, since dealers who work through third-party lenders often get a yes or no back the same day.
• Special incentives: When you finance through a dealership, you often have access to deals and incentives that the bank can't replicate, such as 0% financing or cashback offers.
• Flexible financing options: Dealerships often have access to a wide range of lenders, and this could include subprime lenders that work with bad credit borrowers. This makes dealer financing more flexible and often a better option for borrowers whose credit score isn't in a "good" range.
• Higher interest rates: One of the downsides to financing a vehicle through a dealership is that dealer financing often comes with higher interest rates than banks or credit unions. This is because they're going through a third-party lender, instead of being at the source of lending.
• Dealer Add-ons: Dealerships may stack your vehicle contract with add-ons that are hard to spot, and that you may not know to look for as negotiable items. Things like GAP insurance are often rolled into your contract, and while this is a useful product, it can often be obtained for less by adding it to an existing insurance policy.

Bank Financing: Advantages and Disadvantages

Bank financing, or direct lending, has its own set of pros and cons that come with the opportunity to finance. Here's a look at some ups and downs of direct lending.

• Lower interest rates: Banks and credit unions can provide lower interest rates since they're closer to the source of financing. However, the trade-off is that they don't have access to special incentives and offers that dealer financing can provide.
• Pre-approval chance: When you finance directly through a bank or credit union, you have the chance to get pre-approved. This means that you are given a check from the lender to take to the dealership. This allows you to shop as though you were a cash buyer; you know exactly how much you have to spend.
• Strict credit requirements: To finance through your bank, you typically have to have a good credit score. This often means having a credit score of over 670. That's the standard divide between good credit and bad credit on the FICO credit scoring range. FICO is the most widely used credit scoring model among auto lenders.
• Limited negotiation options: As a cash shopper, you have a certain amount of money that you have to work with. This can be great for a negotiation tactic if you're looking to get a better deal from the dealer's lender. However, it can also cut down on the choice of vehicles you can realistically look at because your budget is set.

Impact on Credit Score

Both dealer financing and direct lending will have an initial impact on your credit score, though the long-term implications really depend on how well you manage your loan, no matter where it comes from. No matter which type of lending you choose, your credit score will be equally affected.

The first impact on your score will come from the initial hard inquiry made on your credit report. In both cases, dealer financing and direct lending, your credit score will take a hit and dip slightly at first. However, with a well-managed loan, you can turn that around and watch your credit score grow.

The fact that you're taking on a new line of credit also adds to your overall lines of credit and has a long-term positive effect of raising your score, assuming you properly manage all your bills. Payment history is the biggest factor that impacts your credit score, so making all your payments on time and in full is the best way to raise your credit score and keep it up over time.

Long-Term Financial Implications

When you're shopping for a vehicle, it's a good idea to take into account the entire loan amount, not just your monthly payment. This is because if you focus on the monthly payment alone, you could potentially end up paying more than you bargained for due to higher interest for a longer period of time. This typically happens when you're using dealer financing, especially if you have to stretch your loan term beyond 60 months to make your payment affordable.

The better option is to take on the shortest loan you can afford, while balancing your monthly payment and interest amount. This can be easier to do when you take on a loan from a direct lender, since you're often eligible for lower interest rates when working directly with a bank or credit union.

Additionally, there's less potential to run into hidden fees when you work with a direct lender. If you finance through a dealership, there is a chance that the dealer could pack the loan with add-ons and additional services or features that will increase your monthly costs. This isn't as likely to happen if you're shopping with a pre-approval from the bank. But, just in case, it's always a good idea to go over all the details in your contract before you sign on the dotted line.

FAQs

What are the typical interest rates for dealer vs. bank financing?

When you finance a vehicle, the interest rate you're given is dependent on your credit score and several other factors. If you have bad credit, you're likely to receive a higher interest rate than if you have good credit. When you're working through dealer financing, the average rate subprime borrowers are offered tends to start around 13% and go up from there, according to Experian's State of the Automotive Finance Market Q3 2025 report. However, this will vary depending on your situation. Bank financing comes in at a lower average, around 7%, and higher, according to a number of sources.

Are there hidden fees in dealer financing?

Dealer financing does carry the risk of hidden fees, but if you're diligent and go over your contract before you sign it, you can typically remove or negotiate the add-ons with the dealer. There is more risk of hidden fees popping up in dealer financing, since the time-consuming process sometimes makes it hard to sit through an entire contract reading, including the fine print. However, this is in your best interest if you plan on getting the lowest possible auto loan you can.

How can I negotiate better financing terms?

There are a number of ways to negotiate better financing terms when you're working with a lender, but your best opportunity will come when you're using dealer financing. If you get pre-approval from a bank, you will actually have a good bargaining chip, where the dealership's lenders can try to get you a better interest rate. You can also choose the shortest loan term possible, as it typically comes with lower interest rates. Or, you can provide a larger down payment, which will lower the amount you have to finance and give you a better chance at lower rates and terms.