What Is an Indirect Loan?
Let me explain what an indirect loan is: it's essentially an installment loan where the lender—whether that's the original issuer or the current holder—doesn't have a direct relationship with you, the borrower.
You can get these loans through a third party with the help of an intermediary, and even loans trading in the secondary market fall into this category.
By letting you obtain financing via these third-party setups, indirect loans can boost funding availability and improve risk management. If you don't qualify for a direct loan, an indirect one might be your alternative, but keep in mind they usually come with higher interest rates than direct loans.
Key Takeaways
- With an indirect loan, the lender doesn't have a direct tie to you, the borrower; you've borrowed from a third party via an intermediary.
- These loans are common in the auto industry, where dealers assist buyers in getting funding from their network of financial institutions and lenders.
- Indirect loans are generally more expensive than direct ones, often serving borrowers who wouldn't qualify otherwise.
Understanding an Indirect Loan (Dealer Financing)
Many dealerships, merchants, and retailers dealing with high-value items like cars or RVs partner with various third-party lenders to help you secure installment financing for your purchases. These dealerships maintain lending networks with multiple financial institutions that support their sales, and often these lenders can approve a broader range of borrowers thanks to their dealer connections.
In the indirect loan process, you submit your credit application right at the dealership. They forward it to their financing network, and you get multiple offers to choose from—the best fit for your needs. The dealership wins too, as facilitating your financing seals the sale. But remember, the interest rate from the dealer is likely higher than what you'd get from a credit union or bank, so I advise you to explore other financing options before committing to dealer financing for your vehicle.
Even though it's called 'dealer financing,' it's really the dealer's network of financial institutions approving the loan based on your credit, setting the terms and rates, and handling payments.
Important Note on Indirect Loans
Although you might get an indirect loan through a dealer or retailer, you're actually borrowing from a separate financial institution.
How an Indirect Loan Works (Secondary Market)
Loans that aren't originated directly by the holding lender can also be indirect. When a lender sells a loan, they hand over responsibility and any interest income to a new owner, who then manages the loan and collects repayments.
I urge you to read any indirect loan contract carefully: if the dealer can't sell the loan you signed to a lender, they might cancel the contract within a set period and require you to return the car. You'd get back your down payment and trade-in value if applicable. In such cases, the dealer might push for a new contract on worse terms, but you're not obligated to sign it.
Indirect Loan Examples
Auto dealerships are among the most typical users of indirect loans; some even classify them specifically as a type of car loan.
You might opt for dealer-financed loans for the convenience of applying on-site and comparing offers easily. However, getting an auto loan directly from a bank or credit union gives you more negotiating power and the ability to shop around for better rates. If your credit history is spotty or your score is low, though, an indirect loan could be your strongest option.
Loans also trade actively in secondary markets, often as pooled loans rather than singles. Banks or credit unions might sell consumer loans or mortgages to free up capital, cut administrative costs, and control risk.
In the home-lending space, for instance, Fannie Mae and Freddie Mac support secondary mortgage trading through their programs. They purchase home-backed loans from lenders, bundle them, and resell them to promote liquidity and fund availability in the market.
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