Getting a car loan can be an overwhelming task. There are many factors to consider, such as budget, credit score, and down payment amount, but once you understand what plays into helping you get approved for an auto loan, it becomes much less daunting.
Table of Contents
Before the Application
Before filling out an auto loan application, there is some research to do. Doing this legwork helps ensure you’ll get a good rate on your loan, and the approval process is a smooth one.
Clean Up Your Credit Score
A credit score is a predictive measurement used by lenders to assess the likelihood of a loan being repaid promptly. Some of the factors considered when assigning a credit score include bill-paying history, unpaid debt, available credit used, foreclosures, bankruptcies, and existing debt in collections.
The higher the credit score, the better. For example, an 800-credit score is considered “exceptional” and will provide far better rates than a 570 score, which is deemed “poor.”
The best loan rates come with this range.
Wide range of rates, all likely high.
Rates will be high, and a loan may be difficult to get.
Not likely to be approved for a loan.
A credit score isn’t set in stone and can be improved in both the short term and the long term. Here are some actionable examples of how to improve your credit score.
- Limit the amount of credit and loans you apply for. Every time a credit score is checked via a “hard inquiry,” it can drop the credit score. Therefore, credit applications should be kept to a minimum.
- Look over your credit report with a fine-toothed comb. If anything on the report seems odd, or you notice any errors, report them at once.
- Keep that credit limit in check. When credit cards are maxed out, lenders take notice. Aim for staying within 30 percent of your credit limit.
- Pay bills on time consistently. Setting up auto payment is one way to ensure bills are paid on or before their due date.
- Pay off credit card balances each month. Credit scores increase with consistent on-time payments. Regular payments prevent the card from being maxed out, which is also key to improving a credit score.
Research Your Options
Now that you’ve got a handle on your finances, credit rating, etc., it’s time to decide what type of car you’re going to purchase. With the sky being the limit for types of car, trim, and other amenities, choosing the type of vehicle you want to purchase will call for quite a bit of research. Here are some things to consider as you put in on your due diligence to discover the right car for you:
If you’re new to the automobile loan process, there may be some terms that are unfamiliar to you. Here’s a quick guide to some terms commonly found in loan contracts:
Gather Your Information and Documentation
Some lenders will require different items than others, but there are some mandatory documents you’ll need when it’s time to apply for a loan. Not all lenders have gone digital, so it’s good to have physical copies of all the following documents:
- Proof of identity – Any government-issued identification — such as a driver’s license — should suffice.
- Proof of income – Most lenders will want to see at least three consecutive months of pay stubs.
- Proof of residence – This can be verified by your driver’s license, but an electric bill with your name and address on it will also work.
- Proof of insurance – You must present current proof of insurance.
- Bank statement – Your bank statement can be used to verify your income.
Consider Your Down Payment and Trade-In Options
A down payment is an initial sum of money applied to a financed purchase. The down payment lowers the loan amount, reducing the accrued interest paid over the life of the loan. Many buyers will use their current vehicle as a form of down payment, known as a “trade-in.”
For example, with an interest rate of 10%, a loan amount of $30,000, and no down payment on a five-year (60-month) term, the total cost will be $45,000. But add in a $5,000 down payment, and the same loan will cost $37,500.
Here’s the formula for calculating your interest rate*:
Principal x Rate** x Years of Term = Interest amount
30,000 x .10 x 5 = 15,000
25,000 x .10 x 5 = 12,500
*How lenders determine interest rates can vary. Use this formula as a guide only.
** The rate is expressed as a decimal
The borrower that can afford a down payment of $5,000 will save $2,500 over the life of the loan. It’s important to note that you can apply a down payment and a trade-in to cut down on the loan payment further.
Apply and Get Approved for a Car Loan
Now that the preliminary legwork is done, there are just a few more steps before getting approved for a loan. The next moves are to collect the loan estimates, set a budget, and get pre-approved for a loan.
Get Loan Estimates and Set Your Budget
A loan estimate is a ballpark number that helps set your budget. When calculating an estimate, don’t forget to consider Tax, Title, and License (TTL), dealer fees, and other costs of ownership such as upkeep, gas, and routine service checkups.
A budget worksheet such as the one provided by the Consumer Financial Protection Bureau can help keep the information organized. Once the loan estimate data has been added, it’s time to begin the pre-approval process.
Get Pre-approved Before Buying
An auto loan pre-approval provides the buyer with an idea of what they can be approved for. The process is like a hard credit check, but the pre-approval won’t affect the credit score. The information in your credit profile and the required documentation submitted are reviewed, and a pre-approval is either accepted or denied.
Although a pre-approval doesn’t guarantee loan acceptance, it’s still a useful tool for the buyer. A pre-approval offer helps the buyer negotiate rates by adding leverage, minus the credit hit.
You can get pre-approved for a car loan at a credit union, bank, or through online lenders.
Review Your Dealer’s Financing Offer
With pre-approval in hand, it’s time to review the dealer’s financing offer. Pay close attention to the rates within the offer. Are they better or worse than the pre-approval? Negotiation is important to secure a good offer, and pre-approval is a key weapon in the buyer’s arsenal.
A pre-approval strengthens the argument for better rates. Remember, if the dealer hedges on terms, there’s no obligation to stick to that lender.
Pick a Loan and Buy Your Car
Before deciding on a loan, compare the loan offers you’ve received. When examining the offers, pay close attention to the interest rate, term length, and monthly payment.
The lowest interest rate can save you thousands of dollars over the life of the loan.
The average term length for an automobile loan is 72 months. Although a longer term is appealing as it lowers your monthly payments, it also adds more time for interest to accrue.
If your budget only allows for a low monthly payment, a longer term can make sense. But if you can afford a higher monthly rate, a shorter term will save a great deal of money over the life of the loan.