What is an indirect loan?
An indirect loan can refer to an installment loan in which the lender – either the original debtor or the current debt holder – does not have a direct relationship with the borrower.
Indirect loans can be obtained through a third party with the help of an intermediary. Loans traded in the secondary market can also be considered indirect loans.
By enabling borrowers to obtain financing through third-party relationships, indirect lending can help improve the availability of financing and improve risk management. Often, applicants who do not qualify for a direct loan can opt for an indirect loan instead. Indirect loans tend to be more expensive – that is, at higher interest rates – than direct loans.
Key points to remember
- With an indirect loan, the lender has no direct relationship with the borrower, who has borrowed from a third party, arranged through an intermediary.
- Indirect loans are often used in the automotive industry, with dealerships helping buyers facilitate financing through their network of financial institutions and other lenders.
- Indirect loans are generally more expensive than direct loans because they are often used by borrowers who might not otherwise be eligible for a loan.
Understanding an indirect loan (concessionaire financing)
Many dealerships, merchants, and retailers who handle big-ticket items, such as cars or RVs, will work with various third-party lenders to help their customers secure tiered financing for purchases. Dealers often have lending networks that include a variety of financial institutions willing to support dealership sales. Often these lenders may be able to approve a wider range of borrowers because of their network relationship with the dealer.
In the process of indirect lending, a borrower submits an application for credit through the dealer. The request is then transmitted to the concession financing network, allowing the borrower to receive multiple offers. The borrower can then choose the loan best suited to his situation. The dealership also benefits, by helping the customer get financing, he makes the sale. Since the dealer’s interest rate is likely to be higher than that of a credit union or bank, it is always best for buyers to check out other financing options before agreeing to finance. their car through a dealership.
Although this type of indirect loan is often referred to as “dealer financing,” it is actually the financial institutions in the dealer network that approve the loan (based on the borrower’s credit profile), set its terms and rates, and collect payments.
Although an indirect loan is offered through a dealer or retailer, the consumer is in fact borrowing from a separate financial institution.
How an indirect loan works (secondary market)
Loans that do not come directly from the lender holding them can be considered indirect loans. When a lender sells a loan, they are no longer responsible for it and no longer receive any interest income. Instead, everything is transferred to a new owner, who takes on the burden of administering the loan and collecting the repayments.
Read any indirect loan agreement very carefully: if the dealer cannot sell the loan that the buyer has signed to a lender, he may have the right to cancel the contract within a specified time and demand from the buyer let him return the car. The buyer then has the right to recover the deposit and the exchange (or the exchange value) if an exchange has been involved. In this situation, the dealership may try to pressure a car buyer to sign another contract on less favorable terms, but the buyer is not required to sign it.
Examples of indirect loans
Car dealerships are one of the most common businesses involved in indirect lending; in fact, some authorities even refer to indirect loans as a type of car loan.
Many consumers use dealer funded loans so they can apply on the spot and easily compare offers. On the other hand, obtaining a car loan directly from a bank or a credit union gives the buyer more leverage to negotiate, as well as the freedom to shop among the dealers. And the interest rates could be better. But if a buyer has an irregular credit history or a low credit rating, an indirect loan may be their best option.
Loans are also actively traded in secondary markets – in particular, a pool of loans that have been combined rather than individual loans. Often a bank or credit union sells its consumer loans or mortgages; this allows lenders to acquire new capital, reduce administrative costs and manage their level of risk.
In the home mortgage market, for example, the Federal National Mortgage Association (Fannie Mae) and Federal Home Loan Mortgage Corp (Freddie Mac) support the secondary mortgage business through their loan programs. These two government-sponsored companies buy mortgage-backed loans from lenders, bundle them and then resell them, in order to facilitate liquidity and increase the availability of funds in the loan market.