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Indirect Loan Definition

By Julia Kagan

Updated November 30 in 2020.

Review by Khadija Khartit

What is the definition of an Indirect Loan?

An indirect loan could be an installment loan in which the lender – whether it is the issuer who issued the initial loan or currently the the holder of the debt is not in direct connection with the borrower.

Indirect loans can be obtained from an intermediary or a third party through the help of an intermediary. Loans trading in the secondary market could also be considered indirect loans.

In allowing borrowers to access credit through third-party partnerships, indirect loans could help improve funding availability and risk management. Most applicants who do not qualify for direct loan could choose to take advantage of an indirect loan instead. Indirect loans tend to be more costly and carry higher rates of interest, for instance – than the direct loans are.

Key Takeaways

When you take out an indirect loan the lender is not in an immediate relationship with the borrower, who borrowed from a third-party, that is managed by an intermediary.

Indirect loans are frequently utilized in the automotive industry dealers assisting buyers get financing through their network of financial institutions as well as other lenders.

Indirect loans tend to be more costly than direct loans, as they are often employed by people who would not otherwise qualify for the loan.

The understanding of an indirect loan (Dealer Financing)

A lot of dealerships, retailers and retail stores that deal with big-ticket things, such as cars or recreational vehicles, collaborate with a range of third-party lenders in order to assist their customers in obtaining installment loans for purchases. Dealerships usually have lending networks which include several financial institutions that are willing to help the dealership’s sales. In many cases, these lenders will be able to approve an array of lenders because of their relationship with the dealer.

In the indirect loan process, a borrower fills out a credit application via the dealer. The application is sent to the financing network for the dealership which allows the borrower to receive multiple offers. The borrower then has the option of choosing the most appropriate loan suitable for their circumstances. Dealers also benefit, in that, in helping customers obtain financing, it helps make the purchase. Because the rate of interest on the dealer’s account is likely to be higher than from a credit union or bank so it is recommended for buyers to check other financing options before agreeing to finance their vehicle through a dealer.

While this sort or indirect loan is sometimes referred to as “dealer financing” in reality, it’s the dealers’ network of financial institutions who approve the loan (based upon the borrower’s credit profile) as well as determining its rates and terms and collecting the repayments.

While it is true that an indirect loan is offered through a dealer or retailer however, the customer is borrowing from a different financial institution.

How an Indirect Loan Works (Secondary Market)

Loans not originated directly by the bank that holds them may be considered indirect loans. If a lender decides to sell a loan they cease to be responsible for it or get any interest from the loan. Instead, everything is transferred to a new owner, who assumes the responsibility of managing the loan and collecting the repayments.

Take note of every indirect loan contract with care: If the dealer cannot transfer the loan the buyer signed with a bank, the lender may have the right to end the contract after certain timeframes and require the buyer to return the vehicle. The buyer will then be entitled to get the back of the down payment and trade-in (or the value that the vehicle was traded in for) in the event that a trade-in is included. In this case the dealer might attempt to force a buyer to sign another agreement with lower terms, but the buyer is not required to sign the contract.

Examples of Indirect Loans

Auto dealerships are one of the most popular businesses that deal with indirect loans In fact, some authorities even call indirect loans the same as a auto loan.

A lot of consumers take advantage of dealer-financed loans because of the ease of being able to apply on-site and compare deals. However, getting an auto loan directly from an institution like a credit union or bank on his own gives the buyer more leverage to bargain, and also the freedom to shop around with dealers. The interest rates could be better. However, if the buyer has a poor credit score or has a poor credit score then an indirect loan may be their best choice.

Loans are actively traded on secondary markets as well – specifically, a collection of loans that have been merged rather than individual loans. A lot of times, a credit union sells its consumer loans or mortgages. Doing so allows lenders to acquire new capital, reduce the administrative expenses and reduce their risk.

In the market for home loans such as for instance, the Federal National Mortgage Association (Fannie Mae) and Federal Home Loan Mortgage Corp (Freddie Mac) support the second-hand trading of mortgages by way of the loan programs. These two government-sponsored companies purchase home-backed loans from lenders, bundle them , and then sell them in order to provide liquidity and increased liquidity across the market for lending.