What Is An Indirect Loan?

In this article, we will look at what an indirect loan is, and how one works. In simple terms, such a loan is one where the lender of the loan does not have a direct relationship with the borrower. This usually indicates that a third party acted as a go-between to source the loan for the borrower. Loans that trade in the secondary market can often be labelled as indirect loans too.

A loan arranged through an intermediary can be beneficial to both lender and borrower. The lender has access to potential borrowers, whilst borrowers have someone to source loans in a crowded market. 

Those that have been declined for direct loans are often more likely to be accepted for an indirect loan. However, they tend to come with higher interest rates compared to direct loans. They tend to be popular in the auto industry.

Dealer Financing

Car dealerships, retailers, and merchants that deal in large-value items such as vehicles, often liaise with third parties to source their customers' financing for purchases. Being well-practiced in this, they should have a network of lenders and intermediaries that help secure finance. Relationships between dealers and lenders means there is more chance of borrowers being accepted for finance, due to the trust that exists within the network.

An example would be as follows:

• To acquire an indirect loan, a borrower submits an application through the dealership stating their credit score, after which the dealer’s financing network assesses its viability
• This process allows the borrower to receive a number of offers for a loan, ensuring they can pick the most attractive one
• It is favorable for the dealership, given they close the sale. Buyers should check options before committing, as rates may be better elsewhere
• The buyer chooses a lender offer from the dealer’s network. Financing is provided, and the vehicle purchased

While often being referred to as dealer financing, it is the network of lenders that provide loans. They set the terms and interest rates, not the dealer. The dealer may provide the car, but the money to do so comes from a separate company.

Secondary Market

When a lender holds a loan that originally was not theirs, it is also referred to as an indirect loan. For example:

• A lender sells a loan from their portfolio and as a result, their responsibility for it ends as does any income they previously received
• The new owner of the loan is instead the recipient of payments and takes on the job of ensuring money is paid back
• The original lender and borrower no longer have a relationship

Buyers should read contracts for indirect loans thoroughly. Should a car dealer be unable to source a lender for a vehicle loan, the terms may allow them to cancel the agreement and repossess the car. In such situations the buyer can retrieve their down payment and any trade-in if applicable. Some dealers may push alternative loans with higher costs, but consumers do not have to accept.

Secondary markets include plenty of active trading of loans. These will usually be loan pools, rather than an individual loan, because it is common for a credit union or bank to sell on its products such as mortgages or personal loans. They do this to free lenders to reduce existing costs and risk, and to free capital for new acquisitions.

When To Use An Indirect Loan

Take a closer look at some examples of when using an indirect loan can be advantageous:

1. The convenience of being able to compare offers and apply on-site is attractive to many. For someone who needs a new vehicle quickly, indirect loans can be a great help
2. The network of lenders the dealer has built up may open up loans otherwise unavailable to consumers
3. If a buyer has a poor or mixed credit history, indirect loans may be their preferred or only option. Those that have been declined for direct loans may benefit from such an option

There are disadvantages however, as taking out a loan directly from a credit union or bank allows buyers the opportunity to negotiate, and the flexibility to look for themselves at what is available on the loan market. Without an intermediary, interest rates are often lower.

Bottom Line

Indirect loans include those that are not agreed to directly between a lender and borrower, and instead being facilitated by a third party or intermediary. They offer convenience to buyers, especially with auto dealerships, where everything can be done quickly on-site, utilizing lender networks. 

They are also an option for those that have been declined for credit elsewhere, but often come with higher interest rates. Consumers should always shop around and consider their options before committing.