Dealer finance vs car loan

What is the difference between car loans and dealer finance?

A car loan is a type of personal loan used to purchase a car. It is a type of ‘secured’ personal loan, with the car acting as security or collateral for the loan. Car loans usually have loan periods typically between one and seven years, depending on the lender.

Dealer financing is a type of loan offered by car dealerships which can allow customers to secure the keys and drive away quicker. Dealer finance often offers lower interest rates than a standard car loan, but may require a balloon payment to be made at the end of the finance period. Dealer finance programs are usually only available for new cars, whereas car loans can be used for new and used cars from private sellers and dealerships.

The main differences lie in cost, convenience and flexibility. Upon walking into a dealership, a friendly person greets you and runs your mind ragged with fast talking and a slick sales pitch. When you’re closing in on a new - or used - car, you’ll likely hear about the dealership’s car financing options.

Cost

You might not know this, but dealers often make very little money on the car sale itself. It’s the extras where they make the profit. Anything from the window tint to the dealer financing can be sold at huge markup.

As the dealer can package convenience as a selling feature, and the car buyer doesn’t have time to compare their options, the interest rate on dealer financing could be lacklustre. However, if the advertised interest rate looks competitive - 0% or 1% dealer financing is a common trope - the devil is in the detail.

• It’s worthwhile looking at the comparison rate. The comparison rate takes into account any extra fees that are applicable. So, the advertised rate might be 1%, but the comparison rate could be over 5% by the time fees are taken into account.

Also look at how the dealer arrived at 0% or 1% finance - does this include a compulsory balloon payment, which could be 30% of the car’s value or more at the end of the loan? Or does the loan revert to a much higher interest rate after a year or two? This might not be something you’re willing to swallow, which takes us to the next point.

Flexibility

From a compulsory balloon payment, to abiding by the car dealership financier’s rules, dealership finance could - but not always - be a less flexible option. If you’re signing on the dotted line of the dealer financing contract, it’s important to read through its product disclosure statement. You might find a few surprises, such as:

• Balloon payments: Dealer financing with the most competitive rates might require a balloon payment of 30% or more at the end of your term. This is usually optional with car loans. This means that as you’re winding up your loan, on a $30,000 car you might need to pay $9,000 of it at the end, which could come as a nasty surprise.
• No extra repayments: Dealer financing might not allow any extra repayments, which allow you to get ahead if you’ve got the cash. Additionally, there might be a fee for paying off your loan early.
• Longer loan terms: While this is applicable for any loan type, the longer the term, the lower your monthly payment might be, but the more interest you’ll pay in the long run.

Additionally, dealership financing’s most obvious restriction is in the name - you’re usually stuck with financing cars that are on the showroom floor.

This generally restricts your car buying options to new cars or used cars only a few years old. While mainstream lenders might also have similar restrictions, if you shop around and compare interest rates, you’ll find there are many car loan options to suit any type of car you want to buy.

Pros and Cons

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