DEFINITION of Dealer Financing

Dealer financing is a type of loan that is originated by a retailer to its customers and then sold to a bank or other third-party financial institution. The bank purchases these loans at a discount and then collects principle and interest payments from the borrower. This is also called an indirect loan.

BREAKING DOWN Dealer Financing

A well-known example of dealer financing is auto dealers that offer car purchase financing. Many car dealers mark up the finance company's interest rate and keep the difference as additional profit.

How Retailers Benefit from Dealer Financing

The so-called buy rate is the interest rate that the financial institution quotes to the dealer for the financing. The actual interest rate the dealer offers to the customer, however, can be set higher than what the buy rate is. Dealers are not obligated to offer customers the best available interest rate, which allows them to set higher rates or longer terms on financing. The dealer might own the actual loan rather than transfer it to other parties.

By offering loans at the dealership, an auto retailer may be able to secure the sale of a vehicle more readily than waiting for potential buyers to arrange financing on their own. The dealer will forward the customer’s information to the financial institutions they have finance arrangements with.

While it might be less expensive for the customer to secure their own loan, dealer financing can reduce the time and effort it takes to do so. Auto dealers often market these loans to customers who might not otherwise qualify for financing because of a poor credit rating or other factors. The interest rates may be higher for such loans or other tradeoffs may be incurred. In some instances, dealers who offer such financing to customers who may be considered high-risk might also install devices in the vehicle that will disable it if payments are not received on time or to aid in the finding and repossession of the vehicle if necessary.

Other retailers, such as boat dealers, might offer this type of financing as well. By granting customers access to financing, retailers can increase the likelihood of a purchase and move more inventory. Dealer financing is comparable to credit cards that retailers may offer. The retailer works with a financial institution to provide the financing, but whereas a credit card or a line of credit may be used for a variety of different purchases, a loan is likely to be put in motion for the purchase of a specific item.