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Indirect Loan Definition

By Julia Kagan

Updated November 30 in 2020.

Reviewed by Khadija Khartit

What Is An Indirect Loan?

An indirect loan can refer to an installment loan where the lender — either the issuer who issued the initial debt or the current the holder of the debt has no direct relationship with the person who is borrowing.

Indirect loans can be obtained from a third party with the help of an intermediary. In the secondary market, loans traded in the market may also be considered indirect loans.

By allowing borrowers to obtain loans through third-party relationships indirect loans can aid in improving the availability of funds and manage risk. Often applicants who don’t qualify for a direct loan could prefer an indirect loan instead. Indirect loans tend to be more expensive — carry higher rate of interest higher more expensive than the direct loans are.

Key Takeaways

In an indirect loan, the lender does not have a direct relationship with the borrower, who has borrowed from a third party, arranged by an intermediary.

Indirect loans are typically used in the auto industry, with dealers helping customers obtain financing through their network of financial institutions as well as other lenders.

Indirect loans are typically more expensive than direct loans due to the fact that they are usually employed by people who would not otherwise be eligible for an loan.

Learning about an indirect loan (Dealer Financing)

Many dealerships, merchants and retail stores that deal with big-ticket items, such as cars and recreational vehicles, will work with a variety of third-party lenders in order to aid their customers to obtain installment loans for purchases. Dealerships often have lending networks that comprise various financial institutions willing to support the dealership’s sales. In many cases, these lenders will be able approve a wider range of borrowers because of their relationship with the dealer.

In the indirect loan procedure, a borrower submits a credit application by way of the retailer. The application is then forwarded to the financing network for the dealership which allows the borrower to get multiple offers. The borrower then has the option of choosing the most appropriate loan for their situation. The dealership also benefits, because by helping the customer receive financing, it makes the purchase. Since the interest rate charged by the dealer will likely be higher than from banks or credit unions so it is recommended for customers to research other financing options prior to deciding to finance their vehicle through a dealer.

Although this type in indirect loan is sometimes referred to in the context of «dealer financing,» is actually dealers’ network of financial institutions that are approving this loan (based upon the credit profile of the borrower) and deciding on its rates and terms and collecting the repayments.

While it is true that an indirect loan is offered through a dealer or retailer, the consumer is actually borrowing from a separate financial institution.

How an Indirect Loan Works (Secondary Market)

Loans not originated directly by the lender who holds them are categorized as indirect loans. If a lender decides to sell the loan they are no longer responsible for it or receive any interest income from the loan. Instead, everything is transferred to a new owner, who assumes the burden of administering the loan and collecting the repayments.

Take note of every indirect loan contract with care: If the dealer cannot sell the loan the buyer signed with a bank, it might be entitled 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 amount of the down payment as well as the trade-in (or the amount from the sale) in the event that a trade-in is included. In this scenario, the dealer may attempt to force a buyer to sign a different agreement with less favorable terms, but the buyer isn’t obliged to sign the contract.

Indirect Loan Examples

Auto dealerships are one of the most common businesses involved in indirect loans In fact, some authorities even call indirect loans the same as a car loan.

Many consumers use dealer-financed loans due to the convenience of applying in-person and easily compare offers. On the downside, obtaining the auto loan directly from the credit union or bank by itself gives the buyer more leverage to negotiate, as well as the flexibility to shop with dealers. And the interest rates might be higher. But if a buyer has a shaky credit score or has a poor credit score and is in need of an indirect loan might be the best choice.

Loans are actively traded on secondary markets too — specifically, a pool of loans that have been merged rather than individual loans. A lot of times, a credit union sells its consumer loans or mortgages; doing this permits lenders to get new capital, lower administrative costs and manage their risk.

In the home-lending market For instance, for instance, the Federal National Mortgage Association (Fannie Mae) and Federal Home Loan Mortgage Corp (Freddie Mac) provide support for the secondary trading of mortgages through their loan programs. These two government-sponsored companies purchase home-backed loans by lenders. The lenders then package them , and then sell them, in order to facilitate liquidity and increased access to funds in the market for lending.