You may have read or heard somewhere that taking out a bank loan is ideal when buying a car. That it beats most other financing options in terms of cost and flexibility. You may also have heard that dealer finance tends to be more expensive and mostly serves to make dealers even richer.
If so, then it’s time to think again. Dealer finance tends to be your best option by far and bank loans may currently be among your worst. Over just ten years, banks have lost a lot of credit (pun intended) with the general public. Other forms of finance, on the other hand, have risen to the top.
That’s not to say that you should never ever apply for a loan with a bank. It just means that it pays to check all your options.
In this article, we’ll show you the benefits of both options – dealer finance versus bank loan – and what you can do to get the best deal. Even if you assume you knew all there is to know about car finance, we’re pretty sure you’ll find something of use for you right here.
Ready to save some money? Then let’s begin.
Table of Contents
- Is there ever an advantage to taking a car loan vs using your savings?
- Some are still highy distrustful of dealerships.
- Car dealers have a very sound reason for offering you car finance.
- Banks are no angels …
- What do you expect from a loan?
- Bad credit score
- Low creditworthiness
- High debt
- Buying a car that’s too expensive
- Too many rejections in the past
- Bank loans: Flexible and simple
- But these benefits come at a cost.
- Dealership loans: Surprisingly great
- What about In-House Financing?
- So which is better: Dealer finance or bank loan?
- What about cash?
What’s the difference between a car loan and a personal loan?
We don’t want to bore you with semantics. But we should at least begin with the basics. To understand why there is such a divide on this topic, you need to understand the fundamental difference between car finance and personal finance.
A car loan is typically secured against the car you’re buying.
This one of the reasons why these loans are so much easier to get approved for. It also explains why they are often slightly cheaper. If something should go wrong with paying it back, the dealership will simply demand you return the vehicle. They may still lose a few Pounds over the transaction. But ultimately, the security significantly reduces their risk.
A personal loan can also be secured.
Usually, this will be against something valuable, such as your house (if you have one) or expensive jewelry.
In most cases, however, personal finance will come unsecured. This places a lot more risk on the financial institution granting the loan. It’s also the reason why so many personal loan providers are careful about whom to extend credit to.
Is there ever an advantage to taking a car loan vs using your savings?
Of course, you could argue: Why take out a car loan in the first place? Why not just opt for a really cheap car and use your savings to buy it?
This is pretty much the philosophy that finance experts like Dave Ramsey have promoted almost obsessively for years. And to be fair: it does make a lot of sense. “Paying with cash gives you, the buyer, a lot of power at the dealership,” argues Car and Driver, because “you can choose to walk away from a deal at any time because you aren’t relying on the dealership for your financing.”
Buying ‘cash’ (which includes any reserves you may have on your savings account) can be a great option:
You’re not stuck paying off a loan for years. There are no monthly payments whatsoever.
- The car is yours straight away. No nasty visits from debt collectors. Plus, you can customise it pretty much any way you want. You’re not losing any money on interest.
- Because it’s yours, you can sell it off easily in case you need money at some point in the future.
- Another often touted advantage is that you won’t have to deal with dealers when it comes to the finance part of the deal. Secretely, after all, we’re all still a bit distrustful of them.
But – should we be?
Some are still highly distrustful of dealerships.
It is true that car dealers do not rank highly when it comes to reputability. In fact, few job groups are held in such low esteem.
Writing about the topic of car finance vs personal loan, Credit Karma lists three reasons why banks are supposedly better:
- #1: A bank won’t pressure you to buy a car
- #2: A bank can preapprove you for a car loan
- #3: A dealer may mark up interest rates
These arguments are so unconvincing that they can only be attributed to a strong personal dislike against dealerships in general:
A bank may not pressure you into buying a car, but that hardly means they are not out to make money on you. The fact that a bank can preapprove you, too, is not an argument for going with them – although this does have its benefits.
Finally, dealers “may” mark up interest rates. But they “may” also decide not to. And besides, so may a bank.
The truth is looking very different these days:
Car dealers have a very sound reason for offering you car finance.
Of course, dealers aren’t charitable institutions. Just like any other company they want to make money. Some have therefore claimed that there’s a conflict of interest for dealers trying to sell finance. In reality, the exact opposite is true: Dealerships are ideally suited to the car loan business and you have everything to gain from it.
Why is this?
Let’s imagine what happens when you take out a traditional private loan with a bank. You apply, you discuss your case and then you’re either granted or denied the loan. Once you have the money, you can pretty much do what you like with it. You don’t even have to spend it on the car (not usually at least).
The bank just wants their money back plus interest. This means they won’t be sympathetic to your case if anything goes wrong. They may have a little to lose if you default. But not enough to keep them from taking harsh measures if they feel they’re appropriate.
Car dealers, on the other hand, are truly invested in your case.
So many people – and this includes experts – claim that dealers just sell car finance to sell you a car. That is probably true. Precisely for that reason, it’s great!
If you get car credit with your dealership, the dealer will try everything in his power to make the deal work. After all, if the conditions are not to your liking, you may take your entire business elsewhere.
Also, he stands to gain the most by keeping you a happy, satisfied customer. Did you know that most dealerships make a lot of their profit by repairing cars? Of course, they could reclaim the car if you can no longer pay your monthly rate. But it’s a lot better for them to find a helpful solution, keep your relationship intact and continue to make money off you.
Contrary to a bank, a dealer actually wants to work with you long-term. They want you to buy as many of your future cars with them as possible. That’s why car finance is inherently ‘better’ than a bank loan.
Besides, banks are no angels …
It is pretty interesting that many experts will often portray the bank loan as the best way to buy a car. In fact, banks have made it increasingly hard for anyone with a less than perfect credit score to be approved. Most of their deals including o% offers, are not even applicable to the average consumer. And when you find yourself in dire straits, you will find that your bank is rarely sympathetic to your plight.
On top of that, the application procedure for most higher bank loans can be tiresome. Although banks have become better and faster at this, they’re still dinosaurs: It takes them forever just to turn their head.
Yes, credit unions are usually a bit more friendly and will often have lower rates and lower acceptance thresh holds. Still, when push comes to shove, they’re still banks.
These are just a few of the reasons why you should never ever set foot into a bank before enquiring about other forms of car finance first.
That said, there is no such thing as a free meal.
Car finance is always going to be a hassle. Ultimately, we’re talking about a lot of money here. For many people, a new or even a used car is either the biggest or second biggest investment they’ll ever make in their life. So it goes without saying that even a few percentage points more or less make a huge difference.
Having to default on a car loan can be a devastating event.
Vice versa, many banks and finance institutions have been burned by bad credits in the past. So they’re trying to play it safe. This, in turn, is making it harder for the less-well-off to get accepted.
What do you expect from a loan?
Let’s begin with what most drivers in the UK expect from their car loan. The following points should be the gauge against to measure whether a private loan with a bank or credit union is best for you or if you’re better off with a dealership loan.
The following three aspects usually decide on the quality of a financial arrangement:
- Cost is by far and large the most important aspect for buyers. In fact, if you’re smart, you will realise that the cost of the loan, rather than the naked cost of the car, will usually decide whether a deal is attractive or not.
- Payback scheme: It isn’t just important how much you need to pay back. What also matters are the conditions of how to pay the loan back. This includes everything from the loan term (i.e. how long you will be paying back) and the monthly rate to your obligations as a loanee and what will happen if you can – temporarily or permanently – no longer fulfil your obligations.
- What happens at the end of the contract. This is relevant because many new financing models don’t actually end in ownership. PPP, which makes up the largest share of the market for new car finance by far, most closely resembles a leasing scheme rather than a buying model for most.
One thing’s for sure: All financing options have their benefits. But whatever option you decide to go for, there will always be issues.
Let’s take a look at these difficulties to see what’s making car finance so hard.
Bad credit score
A bad credit score can directly translate to no car finance. Even if it doesn’t, it can mean that your credit becomes very expensive or that the conditions of the deal are problematic.
We’ve covered this topic in various articles (see for example: How does credit scoring work? ) and our result is always the same: A credit score can never be the full story. And yet, to some financial institutions, it is. Banks in particular are guilty of this.
Whether you think that’s fair or not hardly matters. What does matter is that you either improve your credit score – which is not entirely possible, regardless what you may think – or you can find financial partners to whom the credit score is not the be and end all.
Dealerships fall firmly into the latter category. In fact, here at Concept Car Credit, we will often not look at your credit score at all.
Creditworthiness (also sometimes referred to as ‘ability to repay‘) is a far broader concept to gauge if you are eligible for a loan than just looking at your credit score.
Creditworthiness takes into account a variety of sources to estimate the risk of you defaulting on the loan.
These include your savings, the security of your current job and wage, the ratio of your monthly spendings to your income and many more.
As a result, it arrives at a far more balanced and realistic picture of what you can afford. After a creditworthiness assessment, a dealership may, for example, decide not to deny you finance, but to offer you a deal under certain conditions.
A low creditworthiness is bad news either way. It reduces your chances of success and makes car finance more expensive.
This is not as impossible as it may sound. Your credit score, after all, merely indicates how well you’ve kept up your financial commitments. And if all your other financial indicators are okay, your creditworthiness can be decent even with high debt. Still, high debt can be a serious stumbling block when it comes to finance negotiations.
And, for a very good reason: High debt is an indication that you’re living beyond your means, even if you’re paying off your obligations in time! If a bank refuses your credit application because of this, they may actually be protecting you: Adding a car credit to already sky high debt doesn’t seem like a good idea, does it?
Buying a car that’s too expensive
You’d assume this problem is easy to resolve: Just analyse what you can afford, set a budget and then stick to it. And yet, all too many are finding just that excruciatingly hard.
Here’s a piece of advice: Don’t start looking before you know exactly what you’re looking for. Put down on paper what you need: How many passengers will be using the car on a regular basis, do you have pets which need to be transported using the car, do you have special requirements because of age, size or disabilities, how many miles will you be driving on most days etc. Then, calculate precisely how much money you can spend on the car.
Only once that’s done, start thinking about models and extras.
If you need more directions, here’s an article by Edmunds detailing the ten most important points for finding the right car for you.
Too many rejections in the past
Banks and dealers aren’t private investigators. They have better things to do than sniffing around in your past. One thing they will look at, however, is how often you’ve applied for credit before and how often you’ve been rejected.
This makes sense. After all, as we noted, financial institutions want to make money and they can only make money by extending credit. So if they decide against that, there must be a reason.
By applying for credit often, you’re openly displaying your inability to meet your financial requirements on the basis of your regular income and resources. Regardless how you look at it, that’s not a good thing.
Let’s now take all of these issues and investigate how bank loans and dealership loans fare at resolving them.
Bank loans: Flexible and simple
- There is no middle man, so in theory, bank loans should be cheaper than any other type of finance. In practise, they actually tend to be more expensive, but a lot depends on your situation.
- Bank loans, as we’ve stated before, are very flexible. This means you can apply for more or for less than the price of the car. Depending on your circumstances, this can come in very handy.
- Bank loans are very simple to understand. There’s absolutely nothing fancy about them: You apply for money, you get money, you pay back the money. That’s all there is to it. Compare this to the intricacies and pitfalls of the UK’s most popular finance model, the PPP!
- If you’ve made all payments in good order, at the end of the contract, you’re the owner of your car without fail.
But these benefits come at a cost.
- Banks have a tendency put too much emphasis on your credit score. In fact, some banks will look at nothing but your credit score. This spells trouble if your rating is sub-par.
- Banks will look at your creditworthiness, but they tend to be very strict about this. The conditions of a bank deal are usually set in stone. So although there is some flexibility in terms of how to spend the money, there is very little flexibility when it comes to paying back the loan.
- Because they do not have any other products to sell, banks will be far more severe in enforcing a deal. If you can’t make your payments anymore, chances of a renegotiated deal are slimmer compared to a dealership loan.
Dealership loans: Surprisingly great
Dealerships have significantly improved over the past years and today are perfectly reputable. The simple reason is that dealers have found it far more lucrative to play fair than to try and get as much out of each customer as possible.
As a result, dealership loans are surprisingly great:
- In comparison to bank loans, dealers can today usually get you a cheaper deal. This is because if a dealer applies for a loan, the risk of a default is significantly smaller than if a single customer with a bad credit rating does so. As a result, costs are comparatively low.
- Dealers are doing the actual legwork. So they know the problems many buyers face and are more forgiving. Of course, they want you to spend your money on one of their cars, too … Either way, dealers have a vested interest in a deal happening. Which is why a bad rating is usually not the end of the line.
- For the same reasons, contractual conditions are more flexible with a dealer. Together with you, the dealer will explore every possible combination of loan duration, monthly payments and interest rate to make sure the deal goes through.
- Against popular opinion, dealers won’t typically try to over-sell you an expensive car. What’s the point after all, if you only end up defaulting on the loan?
- On the downside, some dealers may want to sell you insurances, expensive extras or servicing contracts. Here, too, it pays to be strict about what you need and can afford.
What about In-House Financing?
In itself, there is nothing wrong with In-House Financing. By cutting out the middle man, you may even be able to get a better deal, although things don’t always pan out that way. There is also even more leeway when it comes to your creditworthiness, as the dealership only needs to take their own interests into consideration.
On the other hand, you’re also loosing a bit of flexibility in this scenario.
Just like a bank needs to be strict in enforcing its contracts, so will dealerships offering in-house financing. One way of doing this is a black box connected to the motor of your car – if you fail to make your payment, the box automatically switches off the engine. This way, your car will remain unusable until you pay.
Whether In-House Financing is a good or a bad thing depends on the dealership and the details of the deal. In cases like these, it is particularly important to double check the fine print.
Experian, for one, is not particularly enthusiastic about them:
“The costs and down payment requirements on these loans are high, and there’s also a higher chance of repossession.”
So which is better: Dealer finance or bank loan?
And yet, we firmly believe that dealer finance is the better option almost without fail.
The first reason is that, essentially, you are taking out a bank loan – only at better conditions, lower costs and less interest and with more flexibility for those with a bad credit rating.
The second reason is that dealers, as we’ve explained, are actually closer to the product than a bank. They want you to succeed more and will therefore actively try to find solutions to whatever issue arises.
Finally, and this may sound trivial but is actually quite relevant, a dealership loan is so much more comfortable! Sometimes, you can get the paperwork done the same day and you may not need to submit quite as much documentation as with a bank loan.
Plus, you only need to work with one party, which makes things easier as well. Buying a car should be fun as well and dealership loans have a better chance of achieving that.
What about cash?
For one thing, it’s slightly patronising if experts keep insisting that anything other than cash would be a mistake. Some people simply can’t afford to buy a car with their own money, but are perfectly capable of doing so on credit. If you really need a car, car finance is a better option than not getting a car at all.
But there is an even more incisive problem with cash payments (and this includes hefty downpayments as well).
If you pay for a car in cash, you drain resources which could otherwise support you in times of need. Imagine buying a car for 5,0000, paying for it with your savings and then getting laid off a week later.
Sure, your situation would be dire in case of a car loan as well. But at least in that case, you’d still have the 5,000 on the bank which could get you through the rough patch until you find a new job.
Interested in dealership finance?
Then take a look at our options. Concept Car Credit is one of Manchester’s leading providers of car finance with a selection of incredible used cars to match.
Check out our digital showroom and talk to our team for a concrete offer. Who knows, you may be driving home with a new car within the very same day!