Special Financing: What It Is, How It Works

What Is Special Financing?

Special financing is a segment of the auto lending industry for borrowers with a limited or tainted credit history. Special financing in the auto finance industry is risk based, which means that the terms of the loan are set so that the expected returns to the lender/investor are great enough to cover the risk of default by the borrower. Special financing loans typically carry a higher interest rate than is available to borrowers with a clean credit history.

Understanding Special Financing

Consumers who have been through a bankruptcy, had a previous vehicle repossessed, or have some other form of red flag on their credit history might not qualify for traditional financing. Lenders, when reviewing a borrower’s credit record, may note incidents such as repeated late payments, collection notices, and prior defaults as sign of a credit risk.

Some auto dealers offer their own financing options in-house, including special financing loans—also called "special finance" loans—that they may feature in their advertising and marketing campaigns. This can include running ads that claim the dealer will work with consumers regardless of their credit history or if they don't have any money to put down as a deposit. These special finance offers are a way to attract more customers to the dealership and drive up sales.

In the auto dealership industry, dealers can be motivated to clear out as much inventory as possible. The use of special financing is one way for dealers to increase their sales flow, particularly in times when large numbers of consumers may face credit issues.

As with other forms of subprime lending, such as for home mortgages, consumer advocates caution that borrowers may not be fully aware of the higher costs associated with special financing and that they may not be able to afford their payments for the full term of the loan. That could mean losing the car through repossession.

Consumer advocates say there needs to be transparency between the lender and the borrower to determine whether the transaction really makes financial sense. Even with special financing, the customer might not be able to afford the vehicle they are interested in and would be better off choosing a car with a lower price tag.

Like any other product, auto financing is competitive. The best way for consumers to ensure that they are getting a competitive interest rate and fees on a special financing loan is to shop around. But even before doing that, they should make sure that they are not eligible for a regular, less-costly type of auto loan instead.