What Is an Indirect Loan?

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An indirect loan is an installment loan for which the lender doesn’t have a direct relationship with the borrower. Instead, the borrower applies for the loan through a third party, with the help of an intermediary.

Definition and Examples of an Indirect Loan

In an indirect loan, the lender doesn’t have a direct relationship with the borrower applying for the loan. Instead, the lender uses an intermediary to facilitate the loan terms.

  • Alternate name: Dealer financing

The most common example of indirect lending takes place in the auto industry. Dealerships will often work with third-party lenders to finance auto loans for their customers. The dealership’s relationship with its third-party lenders allows borrowers to get approved for a car loan at that location, instead of ushering paperwork between their bank and the dealership.

A dealer may originate the loan, which is then bought by the bank, or it may accept a loan application from a potential buyer then forward the application to the bank. In the latter case, the bank originates the loan. For the dealer, these two indirect lending situations carry the same risk.

How Does an Indirect Loan Work?

An indirect loan is an installment loan where the lender doesn’t have a direct relationship with the borrower. It can take two forms: a company offering a loan to a consumer then selling the loan to a bank, or the company accepting a loan from the consumer for the bank to process and originate the loan.

An auto loan from a dealership is a common example of indirect lending. When you apply for an indirect auto loan, you’ll submit a credit application to the dealership.

The application can go through the company’s financing network, so the dealership will present you loan offers from multiple lenders. This allows you to find the best loan terms and interest rates for your situation. The dealer can forward your loan application to a bank.

The interest rates you receive on an indirect auto loan will likely be higher than what you’d receive directly from a bank or credit union. So explore other financing options before visiting the dealership.

If the dealership originates your auto loan, it will not keep it. Instead, it will sell it to other lenders, such as banks or investors. The new lender would then be responsible for servicing the loan and collecting your monthly payments.

Indirect Loans vs. Direct Loans

Direct lending Indirect lending
The lender has a direct relationship with the customer An intermediary facilitates the transaction between the lender and borrower
Generally less risky for lenders Tends to be riskier for the lender
The lender has more control over the application process and transaction The lender less control as the borrower interacts with the intermediary
For borrowers, the process may take extra steps with the lender and the dealer/company For borrowers, the process is often easier because they deal with one party

If you’re applying for an installment loan, there are two ways you could go about it: apply for a direct loan or apply for an indirect loan.

If you take out a direct loan, the bank or credit union you apply with will issue the loan directly to you. You’ll likely start by working with a loan officer, who will approve you for the loan. Direct lending is usually an ideal path for borrowers with good credit because you’ll qualify for the best terms and rates.

Direct lending is also the safest route for the lender as they have more control over the financial transaction and can approve the borrower’s credentials firsthand.

But for some borrowers, applying for an indirect loan may be a better option. The borrower will apply for a loan with a third-party lender, using an intermediary to facilitate the loan. However, indirect loans are more expensive for borrowers and riskier for the lender.

Pros and Cons of Indirect Loans

  • More convenient for borrowers

  • More opportunities for lenders

  • Higher rates for customers

  • The lender has less control

Pros Explained

  • More convenient for borrowers: Indirect loans are often more convenient for the borrower. For instance, indirect auto loans let borrowers buy and finance a car at the same time.
  • More opportunities for lenders: Indirect lending provides more opportunities for lenders since they have access to a much wider pool of borrowers.

Cons Explained

  • Higher rates for customers: Indirect lending is considered riskier for the lender, so borrowers usually pay higher interest rates. In addition, dealerships are not obligated to present you with the best rate you qualify for.
  • Lender has less control: Since the lender doesn’t have a direct relationship with the borrower, they have less control over the loan transaction. And indirect loans tend to have higher delinquency rates.

Key Takeaways

  • An indirect loan is a loan where the borrower doesn’t have a direct relationship with the lender. An intermediary facilitates the lending process.
  • Auto loans are one of the most common examples of indirect lending, with the dealership facilitating car loans through its network of third-party lenders.
  • Indirect loans tend to be more convenient for borrowers, but you will likely receive higher rates on the loan.
  • Since the lender has less control over the process, indirect lending tends to be riskier.

Article Sources

  1. Federal Reserve Bank of Minneapolis. "Indirect Lending." Accessed Sept. 16, 2021.