Dealer financing is a financing mechanism of indirect loan where a dealer or retailer acts as the intermediary between the financial institution and customers. The dealer gets a loan from the bank on behalf of the customers. The bank provides these loans to the dealers at a reasonable interest rate. Dealers, on the other hand, offer these loans to customers at a higher interest rate to earn a profit. The dealers can also sell these loans back to a bank or a third party at a discounted rate. When this is done, it is the responsibility of the lending banks/financial institutions to collect the payment from the customers – both principal and interest.
Dealer finance is beneficial for all three participating parties - banks/financial institutions, dealers and customers. While dealers get to enjoy increased revenues, because of the high-interest rates they charge for the loans, the customers get all their financing requirements under one roof, without having to spend time visiting different branches for their loans. As more and more dealers/retailers approach the banks for loans on behalf of their customers, it only adds to the business of these banks or financial institutions.
To help you understand how dealer finance works, let us explain it with an example.
Let us consider a scenario where a customer decides to buy a particular brand of car, and he approaches his dealer for the same. The financing of the car is done through dealer finance. The steps that would follow here are explained below:
a) After deciding the model of car, the customer wants to buy, he/she submits a loan application to that effect to his dealer.
b) The car dealer studies the loan application properly and sends it to the banks/financial institutions that are a part of his wide network.
c) When the banks or any other financial institution approves this loan application, the dealer contacts the customer and informs him of the same.
d) The customer studies all the borrowing options at his/her disposal and chooses the bank or financial institution that provides him/her with the most competitive interest rates.
e) The dealer contacts that particular bank to proceed with the loan disbursement. Banks/financial institutions charge a particular interest rate (also known as buy rates) to the dealer for this loan.
f) The dealer gets this loan from the bank and offers it to the customer at a higher interest rate (known as markup) to gain a reasonable rate of profit from this transaction.
g) Sometimes, the dealers sell back the loan to the banks at a discount. In that case, they don’t get involved in any other loan or repayment-related transactions with the customers. The bank will contact the customer directly for all loan-related issues.
h) If the dealer has not sold back the loan to the banks, then the lending bank or financial institutions contacts the customer in case payment has been defaulted. The dealer has the right to claim possession of the product (a car, in this case) from the customer if he/she has defaulted on monthly loan repayments.
Dealers, or retailers, can benefit a lot from dealer financing because there are no hard and fast rules pertaining to the cap on the interest rates, they charge customers for these loans. While it is given that they will charge a rate that is well within the interest rate range of the current market dynamics, still they have an extra edge on this. For example, if a bank offers them a loan at a buy rate of 6%, dealers can give the same loans to their buyers (borrowers or customers) at an increased rate of 9-10%, thereby gaining significant profit on a single transaction.
Most of the borrowers are aware that dealer finance rates are far higher than the bank rates, but they are left with no choice. This is because they are not eligible for a bank loan, maybe due to poor credit history, insufficient documentation and other reasons. Dealers have cordial and credible relationships with many banks and financial institutions. Hence, it is easy for them to secure loans for their customers easily and quickly. This gives them a loyal customer base. In the field of business, more customers mean more revenues.
More and more buyers (borrowers) are opting for dealer financing these days to buy their high-value assets. Here is a brief overview of the pros and cons of dealer finance they should be aware of, before opting it.
a) Loans are quicker and easier to get through dealer financing than through traditional methods.
b) Borrowers don’t have to visit different banks to submit their loan applications; they can get all their loan requirements fulfilled under one roof.
c) If borrowers have a good credit score, they can negotiate with the dealers for better interest rates, in some cases.
d) Even if borrowers don’t have a good credit score or a credible credit history, they can still get loans through the dealer financing scheme.
a) Dealers charge a high markup to the buy rates that they get from the banks; therefore, dealer finance loans are much costlier than bank loans.
b) In dealer financing, borrowers can only get to choose from those options of lenders that are part of the dealers’ network.
Dealer finance loans help financial institutions, dealers and borrowers in a big way. Though they are costlier than traditional loans, they are easy and quick to secure. Choosing a reputed company like Finverv for dealer financing requirements will help all the parties concerned get a good and transparent deal from their transactions. For borrowers with a good credit history, dealer financing can be a very good option, as they are not only assured of quick loans, but they also have a chance to get better interest rates on these loans than the borrowers with a low credit score.