THE BLOG
03/15/2013 06:15 pm ET | Updated May 15, 2013

A Look at the Dangers of On-the-Lot Financing

On-the-lot financing is becoming more popular as many people with bad credit or no credit attempt to buy vehicles. Many banks will not give these customers auto loans because of increased restrictions or egregious risk. As a result dealerships have started creating their own financing schemes to help these poor credit risk applicants.

However, for many, the loans that buy them a dream car turn out to be a nightmare.

Simple Concept, Not-So-Simple Terms

With an on-the-lot finance, also known as a Buy Here Pay Here (BHPH) or an in-house financing, the prospective buyer selects a car at the dealership and then the financing team at the dealership creates a loan based on their financial information.

There are a few positive aspects about on-the-lot financing. On-the-lot financing usually allows people who can't otherwise get a car to finance a vehicle and this method also allows those with bad credit to repair their credit by taking out a loan and hopefully keeping it current. Finally, on-the-lot financing streamlines the process of getting a loan, which many borrowers find confusing and time-consuming.

With those positive aspects in mind, there are some negatives as well. Since on-the-lot financing isn't strictly regulated, percentage rates for these loans can be quite high. On-the-lot financing also promotes irresponsible borrowing by allowing very long repayment plans such as terms of up to seven years. Loans like this will keep a borrower in debt and cause them to pay a large amount of interest. On-the-lot financing can also encourage a borrower to buy a car that they can't truly afford, because the dealerships will often find a way to approve any loan.

Because they will approve any loan, dealerships also often approve no down payment loans. Not only are these loans risky and often involve a higher percentage rate, but it also encourages the buyer to buy a car that is more expensive, and means that the borrower will be paying much more in interest over the term of the loan.

A final problem with on-the-lot financing is that dealership financing departments will often hide fees inside of the loan. These fees can be small loan origination fees for a few hundred dollars, or huge warranty fees for thousands of dollars. A warranty fee over the life of a seven-year loan will cause a borrower to pay hundreds even thousands of dollars in extra interest depending on their annual interest rate. This can be avoided by studying the documents completely, but dealerships are also very skilled in convincing borrowers that they need specific things.

Making a Good Idea Better

While dealership financing does have its place, there are reasons that the government should look into further regulating them. Dealership financing can often be the only way that someone with bad credit can get a car financed. However, this can also be harmful to someone's credit situation because the dealership sometimes encourages the borrower to overextend themselves. If someone is knowledgeable about their choices, it is possible to get a good dealership loan. However, it's also very possible that someone who isn't very aware of their options and how loans work can be taken advantage of.