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Three Types of Auto Financing

Direct Lending

Direct lending occurs when you receive a loan from a credit union, bank, or finance company to purchase a new or used car. This is a contract, or relationship, between you and the lending company. They provide funds for you to pay the dealership, and then you are responsible for paying back the loan amount, which includes the amount financed (i.e. the cost of the vehicle plus taxes, title, and fees) and a finance charge (i.e. interest), to the credit union or bank.

Direct lending allows you to shop around for the best interest rates and terms at multiple lending institutions. When you already know the loan amount and interest rate you’re pre-approved for outside of the dealership, you have a stronger position to negotiate with the dealership and are less likely to be taken advantage of if they offer you financing at a higher interest rate or for a longer term (which ends up costing you more in interest over time, even if the rate and monthly payments are lower).

In the finance office at the dealership, you’ll sign a bankers system contract or a law contract. These are “assignable contracts,” which means they are generic contracts that any lending institution that has already pre-approved you will accept from the dealership.

Dealership Financing with a Manufacturer Contract

Dealership financing is just what it sounds like: a contract between you and the dealership where they provide the financing for the automobile and you make loan payments to them. However, dealerships often sell these contracts to an assignee later on—a bank, credit union, or finance company—and you then make your payments to them.

This type of financing is attractive because it offers added convenience: it’s one less stop to make; you can finance and buy a vehicle in one location. Dealerships can also offer manufacturer-sponsored, low-rate or incentive programs through their own financing if you have a high enough credit score.

If a dealership offers financing options through their relationships with banks, credit unions, and finance companies, know that they are almost always increasing the loan interest rate (APR) to make a profit. This is why it’s best to shop around on your own, first.

Dealership Financing with a Retail Installment Sales Contract (RISC)

A retail installment sales contract can also be used through dealership financing. Like a loan, a RISC obliges you to make payment installments over time for the cost of the car plus interest. The dealership can also sell this contract to a lending institution later. The main difference between an RISC and a loan is when it comes to repossession of a vehicle if a consumer defaults on payments.

After re-possession, a car will be sold at auction and the price it receives applied to the remaining outstanding balance owed by the consumer. There may be a difference between the auction purchase price and the amount still owed on the car. With a loan, the consumer is responsible for making the remaining payments, including interest, until that difference is paid off. With an RISC, depending on state laws, the consumer may not have to make the interest portion of those remaining payments, unless the RISC provides for the charging of interest on a deficiency balance. Under state law, the consumer may also have additional rights if the vehicle proves to have a defect.

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