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If you're buying a car and getting a loan, you have the option to finance the purchase through a bank or the dealership. The right choice between the two depends on a few different factors, and neither option is inherently better than the other.
Depending on your situation, picking one over the other could save you both time and money. Read on to learn more about each option and how to pick the right one.
Financing Through a Bank
Bank financing involves going directly to a bank or credit union to get a car loan. In general, you'll get preapproved for a loan before you ever set foot in the dealership. The lender will give you a quote and a letter of commitment that you can take to the dealer, saving yourself some time when finalizing the contract. Having a specific approved loan amount on paper could also keep the car salesperson from trying to persuade you to include add-ons that you don't need.
Depending on the bank or credit union, you can apply for preapproval online or at a local branch. You may need to provide information about the vehicle, which could cause some delays if you're not yet sure what you want.
The rate offer from a bank or credit union will be the true interest rate and doesn't include any markup, which can happen when you work with a dealer. In general, though, the rate quote you get isn't a final offer. When you head to the dealership to purchase the car, the lender will run a hard credit check and review your full credit report before approving your application and determining your loan rates.
One thing to keep in mind is that your options may vary depending on whether you're buying a new or used car. Some banks and credit unions have limits on the vehicle's age and mileage, and new vehicles may qualify for lower interest rates in general.
Financing Through the Dealer
Dealer-arranged financing works the same way as bank financing—the only difference is that the dealer is doing the work on your behalf.
After you choose your vehicle, the dealer will have you fill out a credit application, which they'll submit to multiple lenders. This allows you to compare rates and terms to choose the best option for you.
In some cases, however, a dealer may negotiate a higher interest rate with you than what the lender offers and take the difference as compensation for handling the financing. In other words, you might not be getting all the information you need to make the best decision.
In general, you can usually get lower interest rates on a new car through a dealer than on a used car. In fact, some dealers may offer promotional financing on brand-new models, including rates as low as 0% APR to those who qualify.
Another form of dealer financing occurs when the dealership provides in-house financing. These buy here, pay here dealerships specialize in working with people with bad or no credit. But the costs and down payment requirements on these loans are high, and there's also a higher chance of repossession.
How to Choose the Best Option
In any situation, it's best to choose the option that will save you the most money. Unfortunately, it's not always easy to know what that option is upfront.
As a result, it may be worth trying to get preapproved by a bank or credit union before you head to the dealership, and then asking the dealer to get quotes as well. That way you can compare and determine which option is best.
It can take some time for you to gather quotes from individual banks and credit unions. Tools like Experian CreditMatch™ allow you to view auto loan offers from several lenders in one place based on your credit score.
If you have bad credit, it may be especially important to look for options through banks and credit unions. Even if the interest rate is higher than you might want, it can still be a better setup than what you'd get with a buy here, pay here dealership.
Regardless of which option you choose, it's important to know that applying for auto loans can affect your credit scores. Every time you apply for a loan, the lender runs a hard inquiry on your credit report, which can knock a few points off your score.
Applying for multiple loans in a short period can compound that negative impact, but if you do all your rate shopping in a short period—typically 14 days, but sometimes longer—all the inquiries are combined into one when calculating your credit score.
Prepare Yourself Financially Before Applying for an Auto Loan
Understanding how to get the best financing for your car is important, but it's just as important to prepare yourself in other ways. For starters, check your credit score to see where you stand. If it needs work and you have time, consider taking steps to improve your credit before you apply.
Also, work on saving a down payment for the loan. The higher the down payment, the less you have to finance, and the less you'll pay in interest over the life of the loan.
Finally, check your budget to make sure you can afford the monthly payment. The last thing you want is to drive off the lot in a car that will cause you more distress than joy.
Editorial Disclaimer: Opinions expressed here are author's alone, not those of any bank, credit card issuer or other company, and have not been reviewed, approved or otherwise endorsed by any of these entities. All information, including rates and fees, are accurate as of the date of publication.