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Indirect Loan Definition

By Julia Kagan

Updated November 30, 2020

Reviewed by Khadija Khartit

What Is the definition of an Indirect Loan?

An indirect loan can refer to an installment loan in which the lender, whether the issuer who issued the initial debt or the current owner of the debt does not have a direct relationship with the person who is borrowing.

Indirect loans are obtainable through an intermediary or a third party through the assistance of an intermediary. Loans trading in the secondary market may also be considered indirect loans.

In allowing borrowers to access financing through third-party relationships, indirect loans can help to improve the availability of funds and manage risk. Most applicants who do not qualify for a direct loan could opt for an indirect loan instead. Indirect loans are generally more expensive – carry higher rates of interest, for instance more expensive as the direct loans are.

Important Takeaways

In an indirect loan the lender is not in any direct contact with the borrower, who borrowed from a third party which is arranged through an intermediary.

Indirect loans are frequently used in the auto industry dealers assisting buyers get financing through their networks of financial institutions as well as other lenders.

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

Understanding an Indirect Loan (Dealer Financing)

Many dealerships, merchants and retailers that handle big-ticket things, such as cars or recreational vehicles, are able to work with a variety of third-party lenders to aid their customers to obtain installment loans to finance purchases. Dealerships typically have lending networks that comprise several financial institutions that are willing to help the dealership’s sales. Sometimes, these lenders might be able to approve more borrowers because of their relationships to the dealership.

When it comes to the indirect loan procedure, a borrower fills out a credit application via the dealer. The application is then sent to the dealership’s financing network which allows the borrower to be offered a variety of loans. The borrower then has the option of choosing the most appropriate loan suitable for their circumstances. Dealers also benefit, because in helping customers obtain financing, it improves the purchase. Since the interest rate charged by the dealer’s account will likely be higher than that of banks or credit unions so it is recommended for customers to research different financing options before deciding to finance their vehicle through the dealer.

Although this type of indirect loan is commonly referred to as «dealer financing,» it’s actually the dealer’s network financial institutions who approve this loan (based on the borrower’s credit profile) as well as determining its rates and terms and collecting the loan payments.

Although it is true that an indirect loan is offered through retailers or dealers however, the customer is borrowing from a different financial institution.

How does an Indirect Loan Work (Secondary Market)

Loans not originated directly by the lender who holds them are categorized as indirect loans. If a lender decides to sell a loan they are no longer responsible for it or receive any interest income from it. Instead, all the assets are transferred to the new owner, who is able to take on the responsibility for managing the loan and collecting the repayments.

Take note of any indirect loan contract very carefully The dealer is not able to sell the loan the buyer signed to a lender, the lender may have the right to terminate the contract within certain timeframes and request that the buyer return the car. The buyer is then entitled to receive the deposit and trade-in (or the value of the trade-in) if a trade-in was included. In this case the dealer might attempt to force a buyer to sign a different agreement with lower terms, but the buyer isn’t required to sign the contract.

Examples of Indirect Loans

Auto dealerships are among the most common businesses involved with indirect loans; in fact, some authorities even call indirect loans a type of auto loan.

A large number of people take advantage of dealer-financed loans for the convenience of being able to apply on-site and evaluate offers. On the downside, obtaining an automobile loan directly from an institution like a credit union or bank by itself gives buyers more leverage to bargain, and also the freedom to shop around among dealers. The interest rates could be better. However, if the buyer has a spotty credit history or a low score then an indirect loan could be the best option.

Loans are actively traded on secondary markets too – specifically the group of loans that have been merged instead of individual loans. Often a bank or credit union offers its customers loans or mortgages. Doing this allows lenders to obtain new capital, cut administrative costs and manage their risk.

In the market for home loans such as there are two organizations: Federal National Mortgage Association (Fannie Mae) and the Federal Home Loan Mortgage Corp (Freddie Mac) support the secondary trading of mortgages by way of their loan programs. These two government-sponsored enterprises buy loans that have a home backing loans from lenders, bundle them and then re-sell them in order to provide liquidity and increased availability of funds across the lending market.

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