Using a Captive Finance Company: Disadvantages

One way to finance a large purchase is to use a captive finance company. While many people feel that captive finance companies are the way to go when financing anything, there can be disadvantages to the process.

Knowing what a captive finance company is can be an important part of dealing with them. A captive finance company is basically an in-house lending firm for a bigger company. The car industry has the best examples of these. For example each of the big three car makers has their own lending companies.

In layman's terms a captive finance company is basically in-house lending. Car dealerships are the most widely known examples of these. When you go to a dealership that only deals with one brand of cars, you can apply and get financed by that company's own lending institution.

One of the main disadvantages to captive financing is that a borrower could potentially be approved for a loan that they can't afford. Captive financers sometimes offer loans to people with bad credit. An uneducated consumer could potentially engage themselves with a loan that far exceeds what the car is worth. If they are not careful, the captives will inflate the loan in the interest of making bigger profits for the parent company. People with bad credit usually get high rates anyway, but a captive could inflate these to more than twice as much as other lenders may do. They also typically give shorter loan periods, making monthly payments extremely high. Captives do this because they are owned by the car company. The more a borrower spends on a loan, the more money the car company ultimately makes.

Not only do captive companies charge high rates but sometimes they will use dishonest methods with their loan terms. There are several things that captives have been accused of doing. Overcharging and flat out using trickery in the loan terms are ways of making money for the car company, and this happens especially with people with lower or no credit.

Another drawback that this system creates is that it gives the salesman an incentive to create more cost for the car. The salesman knows that the bigger the loan is, the more commission they will make off the deal. Often the borrower has no idea this is going on. They may see a certain price for a car, and completely disregard anything but affording the monthly payments. Unbeknownst to the borrower, to get this special price they have to have a ridiculously high APR, or the car salesman is adding things like extended warranties, and car mats, that the borrower doesn't need and might not even want, jacking the total price of the car up much higher than borrower expected.

This makes the loan much bigger and ultimately creates more interest payments, which is where the company really makes its money. There is any number of these kinds of tricks that the dealership will use to make the loan larger. So anyone dealing with a captive financer must be alert and attentive when using their services.