An indirect loan is a type of installment loan where the lender and the borrower do not have any direct relationship. Instead, the borrower goes through a third party to apply for a loan, with intermediary help. A good example of an indirect loan happens in the auto industry. The dealership facilitates auto loans through its third-party lender network.
This enables borrowers to get a car loan approval at that location instead of ushering documents between the dealership and their bank. An indirect loan tends to be more comfortable and easier for borrowers. However, it may come with higher rates. And since the lender has little control over the lending process, this type of loan tends to be risky for lenders.
How Does an Indirect Loan Work?
In layman’s terms, an indirect loan is a type of installment loan where the lender and borrower don’t directly interact. There are two different ways this can happen: a company offers a loan to a consumer and then sells it to a bank, or the company accepts a loan application from the consumer for the bank to handle and approve it.
Just like I have mentioned above, a good common example is an auto loan from a car dealership. When you apply for an auto loan at the dealership, you will have to submit a credit application.
The dealership will then send your application to its network of lenders. This gives you lots of options to choose from, with different terms and interest rates. Keep in mind that the interest rates you will get will be higher than what you get directly from a credit union or bank. The dealership might then send your application to a bank. If the dealership sets up the loan, it will sell it to other lenders, like banks or investors. This new lender will then manage the loan and collect the monthly payments from the borrower.
Indirect Loans: Pros and Cons
To understand more about this indirect financing, the advantages and disadvantages are below. Check it out.
Pros;
- This type of loan is easier and more convenient for the borrowers. For example, indirect car loans allow the borrowers to purchase and finance a vehicle at the same time.
- It offers more chances for lenders since they get access to a wide pool of borrowers.
Cons
- It is hazardous for lenders, so it usually comes with very high interest rates.
- Dealerships are not mandated to offer you the best rate you can afford or qualify for.
- Since the lender does not have direct interaction with the borrower, they don’t have much control over the loan process.
- It tends to have very high delinquency rates.
You should explore different options when applying for this loan. Because it tends to put lenders at greater risk, it comes with very high interest rates. Ensure that there are no other options you can qualify for before considering this financing option.
Direct Loans vs. Indirect Loans
| Direct Lending | Indirect Lending |
| Lenders do have direct interactions with the borrowers. | An intermediary is in between the lender and borrower transaction. |
| Less risk for lenders | It is more risky for lenders. |
| The lender has more power over the application and transaction processes. | The lender does not have much power as the borrower has a relationship with the intermediary. |
| For borrowers, the procedure may take more steps with the lender and the company or dealer. | For borrowers, the process is very convenient because they only deal with one party. |
Conclusion
When applying for an installment loan, there are two options available for you: a direct loan or an indirect loan.
For a direct loan, you will have to apply directly with a bank or credit union. You’ll typically work with a loan officer, who will help you get the loan approved. This is a good option if you have a good credit score, as you’ll get affordable rates and terms. It is very safe for the lenders since they have more power over the transaction process and can verify your information themselves.
Finally, it involves applying through a third-party lender who acts as an intermediary. This option can be very expensive for borrowers and riskier for lenders. However, it might be a better option for some people, depending on their situation.