Getting a car loan: bank financing or dealer financing?

By: Robb Engen on August 20, 2024

When it comes to buying a new car is to purchase it with cash. However, that's unrealistic for most people, so borrowing is the only feasible alternative. Two places you can obtain a car loan are a bank and a dealership. But which one should you choose?

How does financing a vehicle work?

Financing a vehicle involves getting a loan from a lender equal to your car's cost, less any down payment, to make your purchase. This lender can be a bank, credit union, auto dealership, or any other lending company willing to extend credit to you.

You must repay the borrowed principal over a defined period, usually one to seven years, along with interest. Most auto loans charge a fixed interest rate, so your monthly payments will never change during the loan period.

An auto loan is a secured loan, as your vehicle functions as collateral for the amount owed. That means your lender can repossess your vehicle if you stop making payments and sell it to pay off the outstanding balance. Once you finish paying off your auto loan in full, you'll have 100% equity in your vehicle.

Getting a car loan from a bank

One of the most popular ways to finance a vehicle purchase is through a bank. Many people choose this route because they prefer doing business with a lender they trust and already use for their daily banking needs.

There are also other benefits to obtaining an auto loan from a bank:

Low rates. You’re more likely to get offered a lower interest rate than dealerships.

You pay less for longer. You usually have access to loans with longer terms, potentially up to eight years, which translates to smaller monthly payments.

More dealership options. You can buy a car from any source, including private sellers.

While banks offer competitive rates and flexible terms for car loans, only some borrowers can access them. To qualify for a car loan from a bank, you must meet credit score, income, and debt service ratio requirements, which vary based on the bank. Getting approved can take as little as one or two days.

If you don’t have a steady income or a good credit score, your loan application will be rejected or approved only with a steep interest rate.

Getting a loan from a dealership

A convenient and fast way to finance a car purchase is to obtain a loan directly from the dealership. You can get a credit check, secure pre-approval, negotiate loan terms, and sign the necessary paperwork — all in one place.

Other advantages to getting an auto loan from a dealership include:

More lender options. Dealerships usually partner with multiple loan providers, including credit unions, alternative lenders, vehicle manufacturers, and banks, giving you plenty of financing options.

Lower eligibility requirements. Compared to banks, dealerships have more relaxed lending standards. That means you may be eligible for a loan even with bad credit and a lower income.

Access to rebates and discounts. Dealerships routinely add discounts and promotional interest rates (like 0% financing) to attract customers. The vehicle manufacturer may also offer rebates, which the dealership can apply to your loan to reduce borrowing costs.

However, interest rates on dealership car loans tend to be higher than those from banks. This is partly because dealerships collect a commission on loans they originate and may add a markup on interest rates provided by their lending partners to earn an extra profit.

Also, dealerships typically offer shorter loan terms, which results in higher monthly payments. They may also ask for a down payment before considering your application.

Lastly, getting a loan from a dealership means you can only buy a car from their inventory, which significantly limits your options.

Leasing: a popular alternative to buying a car

People who need vehicle access but aren’t ready to purchase a car can lease one. When leasing a car, you rent it for a fixed period from the dealership, usually two to five years. Instead of paying off a car loan and building equity, you pay a monthly fee that covers the car's depreciation.

Once your lease expires, you can return the vehicle to the dealership or purchase it.

Your dealership will negotiate the lease terms with you, including the vehicle's value, monthly payment, interest rate, lease length, fees, and maximum kilometres you can drive annually. Most likely, the dealership will require you to purchase collision and comprehensive car insurance (and possibly gap insurance).

When you lease, you’ll save money and gain access to a newer car with the latest features. The monthly payments are typically lower than auto loan payments, there are fewer upfront costs, and the warranty protection usually spans the entire lease period.

But if you can finance the purchase at an affordable rate and afford the cost of repairs and maintenance, you might consider buying — especially if your job or personal life requires you to travel long distances or you plan to modify your car (a lease restricts your mileage and prohibits vehicle customizations, like hand controls).

Does how you pay for your car impact your auto insurance rate?

How you pay for your vehicle isn’t a risk factor that car insurance companies consider when determining your auto insurance rate.

However, if you use a loan, your lender could require you to purchase collision and comprehensive insurance, resulting in a higher premium. Since they have a financial stake in your vehicle — especially if it’s a leased vehicle — they want to ensure it's protected in case it suffers extensive damage or gets totalled.

Should you get your car loan from a bank or dealership?

Whether you get your auto loan through a bank or dealership depends on the strength of your finances and the interest rate offered.

If you have good credit and are looking for a long-term loan, a bank can offer competitive interest rates and zero-down payment financing, as well as no restrictions on where you can buy your car.

However, if you plan to contribute a down payment and pay off your loan fast, or your credit isn't in the best shape, you might be better off with dealership financing.

Whatever option you choose, crunch the numbers to determine what you can afford and get pre-approved for financing. That way, you'll be better prepared to negotiate with lenders when shopping for the best auto loan deal.