Dealer financing vs getting a car loan from a financial institution: Which is best for me?

There are pros and cons to both options, but you may be able to get a better rate from a bank or credit union than you might through a dealer.

Anna Swartz 1600

Anna Swartz

Published August 1, 2019

KEY TAKEAWAYS

  • Both dealer financing and loans from banks have benefits and drawbacks

  • Dealerships may have higher rates, but they are usually more willing to negotiate

  • The most important thing to do is shop around and make sure you’re getting the best loan offer

Car-buying is no simple process, there’s the matter of picking out the right type of car for you, scrolling through car listings online or spending your weekends at dealerships — and then there’s the process of figuring out how to pay for it. Some drivers can afford to pay for their new or used car in cash and then just drive it off the lot, but that’s not an option for most people. So lots of drivers choose to pay for their cars with an auto loan, paying off their vehicle over time, plus interest.

But once you’ve decided to finance your car, how do you decide where to get a car loan? Shopping for auto loans at banks and credit unions can get you better rates, but financing through a car dealership gives you the convenience of a one-stop-shop. Let’s take a closer look at some of the pros and cons of dealer financing and a car loan through a financial institution.

In this article:

How do car loans work?

Car loans basically work like any other secured loan — a lender agrees to loan you the money you need to purchase the car, and you agree to pay back the loan over an agreed-upon length of time, plus interest. The car itself “secures” the loan, meaning it acts as collateral, and if you can’t pay back the loan on time, the lienholder may take possession of the car.

While it’s tempting to choose an auto loan offer based on whichever one offers you the lowest monthly payment, the lifetime cost of a car loan actually depends on a number of factors. A long loan term, which is the length of time you have to repay the loan, may mean lower monthly payments but, because you’re paying interest for longer, it may cost you more over time than a shorter loan with higher monthly payments (for reference, many auto loan terms are between 36 and 72 months).

Making a bigger down payment will cost you more upfront, but it could save you money over the life of the loan. The chart below shows why choosing the loan with the lowest monthly payment can increase the total amount you’ll pay over time, depending on other factors like down payment and APR.

Purchase PriceDown PaymentInterest RateLoan TermMonthly PaymentTotal interest Paid Over Time
Loan A$20,000$2,0003%48 months$398$1,124
Loan B$20,000$2,0004%24 months$782$760
Loan C$20,000$2,0003%36 months$523$845
Loan D$20,000$5,0003%36 months$436$704
Loan E$20,000$03%36 months$582$938
Loan F$20,000$3,0005%72 months$274$2,712

No matter where you’re getting your car loan, it’s important to shop around and compare offers across these multiple factors to make sure you’re getting the most bang for your buck.

Learn more about how car loans work.

How much does credit score matter?

Your credit score is one of the biggest factors in determining what kind of loan offers you’ll get. The higher your score, the lower your interest rate will be, and vice versa. If you have a poor credit score, you’ll be considered a subprime borrower and it will be difficult, but not impossible, to secure financing.

If your credit score puts you in this category, you might want to consider getting someone with a better credit score to co-sign with you, or put off buying a new car until you can pay off other debts and increase your score.

As for how much applying for a loan will affect your credit score, the truth is that whenever lenders run a hard inquiry to check your credit, it will ding your credit score slightly. But when you’re applying for car loans, even if multiple lenders check your credit, it will only count as one hard inquiry as long as they do it around the same time.

Learn more about how credit scores affect car loans.

Pros and cons of getting a loan through a bank or credit union

One option when shopping for an auto loan is to go directly to a financial institution, like a bank or a credit union. Benefits of using a financial institution include:

  • Established relationships. If you get financing for your car through a bank or credit union with which you already have a financial relationship, you may be able to secure a better rate. For borrowers with poor credit, a local bank or credit union may also be more willing to work with you if you’ve already worked together in the past.

  • Borrowing directly from the source. If you borrow from a bank or a credit union, there is no middleman, you’re borrowing directly from the institution that lends you the money. That means no extra fees, and you may get lower rates.

  • Convenience. If your bank or credit union has local brick-and-mortar locations, it may be easier to meet in person if you need to renegotiate your loan terms.

But borrowing from a bank or credit union also has its drawbacks, including:

  • Less wiggle room. A bank or credit union will likely be less willing to negotiate on APR, which is essentially your interest rate.

  • More to juggle. Getting a loan through a bank or credit union can make your car-buying process a little more complicated than doing the whole kit and caboodle at the car dealership.

Pros and cons of getting a loan through a car dealership

Many car buyers get their car loans at the dealership where they buy their car, making the whole process slightly more streamlined. But dealerships may have extra fees and add-ons along with their financing, so uninformed buyers can find themselves paying more than they mean to. That said, there are benefits to dealer financing, including:

  • Promotional pricing. Dealerships may offer promotional offers, like 0% APR on certain models of new cars, that can make going with dealer financing a better deal than a bank or credit union. However those offers may only be available to drivers with excellent credit.

  • One-day shopping. Going with dealer financing means you’re getting your car and your car loan all in the same place, so you can show up at the dealership and drive away with your car in one afternoon. However, even if you plan on accepting your dealership’s loan, you should still shop around for car loans to give you more leverage during negotiations.

  • Room to negotiate. Dealerships are acting as a middleman when they arrange financing for you, so in order to make money on the loan, they may offer higher rates. That said, dealerships also are usually willing to negotiate the rates, so if you show up with a loan offer from a bank or credit union, you can try asking the dealership if they can offer you a lower rate.

Dealership financing also has some drawbacks, including:

  • Higher rates. As we mentioned above, the rates offered at a dealership may be higher than those offered by a bank or credit union, as the dealership is acting as a middleman and needs to make some money off of your loan. That’s why it’s so important to shop around before you decide on a loan offer.

  • No personal relationship. Your dealer may offer you financing through a bank or institution that you have no prior relationship with, and if you need to negotiate the loan down the line or find yourself at risk of falling behind on payments, it may be harder to make that happen.

No matter where you decide to get your auto loan, the most important thing you can do to save money on a loan is shop around. And once you’ve settled on the best offer and you’ve got your new car, don’t forget to reevaluate your car insurance. Policygenius experts can help you compare quotes from top auto insurance carriers and make sure you’re getting the best coverage for your new ride.

Policygenius’ editorial content is not written by a certified financial planner or advisor. It’s intended for informational purposes only and should not be considered legal, financial, or investment advice. Consult a professional to learn what financial products are right for you.

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