What you need to know about captive lenders before using one for your car purchase

What you need to know about captive lenders before using one for your car purchase

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  • Captive lending is a type of in-house financing often found at car dealerships.
  • This type of loan is convenient and often more flexible than other financing options.
  • You may pay a higher price or interest rate with captive lenders than with other lenders.

If you’ve ever bought a car, you may have used captive lending, a type of in-house financing that car dealerships typically offer.

According to Experian, about 46% of new car purchases this year were financed by this type of financing. Two years ago, it was almost 60%. Are you considering a captive lender for your next purchase? Here’s what you need to know about this practice and its pros and cons.

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What is captive lending?

Captive lending, sometimes called internal financing, allows customers to finance a purchase directly through an affiliate of the lender and spread the cost (plus interest) over time. You will typically apply for captive financing on the spot at the point of sale.

“If you’re at a dealership ready to buy a car, and the dealership says they can help you pay for that car with an in-house loan, that’s an example of captive financing,” says Howard Dvorkin, author, public certified. accountant (CPA) and president of Debt.com.

Consumers will most often encounter captive lenders at dealerships, but retail outlets sometimes offer them as well. Common industries that use captive financing include:

  • Medical suppliers or providers
  • Secondary education and trade schools
  • wholesale clubs
  • Buyers’ clubs
  • heavy equipment suppliers
  • home improvement companies
  • Musical instrument retailers
  • Medical spas

A company may offer captive financing for many reasons. It can create an additional source of income, limit its risk or differentiate itself from its competitors.

“They may be looking to create a competitive advantage over other vendors in their industry,” says Shaun Lucas, CEO and President of Monterey Financial Services. “Traditional loan options available to consumers are often limited in terms of term, interest, prepayment and underwriting options. Taking the option to finance internally gives the business more control over the financing terms offered, helping to further simplify the customer’s purchase.”

What are the advantages of captive financing?

The main advantage of captive financing is greater flexibility to customize the terms according to the client’s needs and budget. The company also has more control over loan underwriting, which can help consumers — especially those with low credit scores — qualify more easily.

“This can be a good option for someone trying to build credit because they can approve someone a traditional lender may not approve,” says Carlos Legaspy, president and CEO of Insight Securities. .

Captive lenders are also convenient and often offer unique discounts, rebates and promotions – like 0% introductory APRs – that are not available with more widely used financing options. These benefits can save consumers money, both upfront and in the long run.

You may have to choose between promotions (like a lower interest rate or cashback, for example) when using a captive lender. Additionally, your introductory rate may only be valid for a limited time. Read the fine print and know when and how much your interest rate may increase.

What are the disadvantages of captive financing?

According to the Consumer Financial Protection Bureau, internal financing can sometimes come with inflated prices and higher interest rates compared to other types of financing.

You may also encounter aggressive upselling tactics with captive lenders, which could mean buying expensive add-ons or upgrades you don’t have the money for or don’t need.

“The main downside is that interest rates tend to be higher, and for an unruly buyer, that can tempt them into buying something they can’t afford,” says Legaspy.

Is a captive lender right for you?

Captive lenders may be smart for some consumers, but they’re not for everyone. The right choice depends on the type of car you’re considering, your budget, credit score, and other factors. Also, not all dealerships offer in-house financing, so a captive lender could limit the brand of car you can buy.

If you are unsure of the right decision, speak to a financial professional or credit counselor who can advise you.

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