If you’re planning to buy a vehicle, the odds are you’ll be doing so with help from a car loan — since more than half of all cars are bought this way. With interest rates so low right now, such borrowing is especially appealing.
A lot of car buyers start their shopping by selecting the car they want, and then initiate steps to finance it. That’s not the best order of play, according to car-buying experts. If you research (and even secure) your loan first, rather than your vehicle, you’ll be better informed about how much you can afford to spend before you begin to kick tires and take test drives.
Used-car buyers can buy a vehicle with a car loan, but only if it’s from a car dealer franchised by a major car manufacturer. The only financing option for a private-sale used car purchase is a personal loan — which will have a higher interest rate than a car loan.
This guide runs down the steps to get a car loan, including the best ways to shop for the loan and how to narrow down your choice of lenders.
Step 1 for Getting a Car Loan: Check Your Credit Score
Verifying your credit score allows you to start shopping for a car loan armed with the best idea of whether you’ll be approved for a loan and if you are, the amount, interest rate, and loan term you might receive. The better your score, the better those terms if you take out a loan. (Our advice is mostly aimed at those with solid credit scores. If you have poor credit, see the section at the end of this guide.)
Checking your score has other benefits, apart from preparing to get a car loan. It also allows you to validate the information in your credit reports, and to ensure that no errors or other issues are unfairly hurting your credit history or lowering your credit score. The good news is that you get to see, for free, what’s on your credit rap sheet. You can view one free report per bureau per year by going to annualcreditreport.com and filling out a form.
Your credit score isn’t the only factor lenders consider during the application process, according to Experian, one of the credit bureaus that generates those scores. They’ll also look at your credit report, your debt-to-income ratio (DTI) — your monthly debt payments relative to your gross monthly income — your employment history, and other factors. But a score that’s at least good — defined as 670 or more by FICO — makes it more likely you’ll be approved for a car loan, and at the best terms. If it’s in the fair range, Experian says, you’ll likely qualify as well, though you may have to settle for an offer that carries higher interest charges or fees or requires a relatively high down payment.
Step 2 for Getting a Car Loan: Shop Around
You’ll invariably be pitched a car loan by the dealership, assuming that’s where you buy the car. Dealer loans on new cars are often subsidized by the manufacturer, and so can be a good option for many who have good credit, according to Consumer Reports.
But car buyers shouldn’t make the dealer the only place they shop for a loan. You may find better terms elsewhere, or gain insights from your research that better arms you to negotiate with the dealer over the car’s cost and the terms of its financing. Your bank or credit union is another easy shopping option, especially if you already have a beneficial personal relationship there. If you’re not a credit union member, consider joining one (using this federal site), since car loans from these institutions may offer lower rates and fees than banks. You can also pitch your car-loan business to online lenders, which may also offer better rates than your bank. Sites such as Clearlane (operated by Ally Bank), E-Loan, and LendingTree allow you to gather multiple loan quotes with a single application.
However, Consumer Reports warns that these applications may prompt an annoying flurry of phone calls or emails, and the resulting loan may have higher fees than some other options. Ask about different terms and down payments and see how they affect your monthly payments. You might also want to ask about prepayment: if you get a windfall, can you opt to pay down the loan amount? With what penalties, if any?
Step 3 for Getting a Car Loan: Get Pre-Approved
With your shopping research done, it’s time to get a loan commitment — or even a number of them.
As you shop around, prospective lenders will have given you what are known as loan pre-qualifications for your loan amount. These signal the likelihood that they will give you a loan, along with its probable principal and rate, but fall short of being a precise, binding quote. Such specificity requires pre-approval, which is a more involved process.
While pre-qualifications require only estimated figures — of your annual income, monthly housing costs, and savings, as examples — pre-approval demands submitting such documents as tax returns, pay stubs, and bank statements. A formal credit check is also required. Where pre-qualifications involve only an invisible “soft” inquiry about your credit score, the “hard pull” of the pre-approval process will show up on your credit history. Every pull shaves a few points from your credit score, as a rule. However, with auto loans and mortgages, multiple inquiries within a given period of time (typically 14 to 45 days) are generally counted as one inquiry, according to credit bureau Equifax. That fact means you can seek pre-approvals from several lenders — to compare their offers precisely — with little or no risk of accumulating damage to your credit score. The main variable is the time you’re prepared to devote to submitting the necessary documents to each lender.
Step 4 for Getting a Car Loan: Shop for Cars With Your Pre-Approval in Hand
A pre-approval notice allows you to know exactly how much car you can buy. But don’t spend all of its principal, since you’ll also need to pay taxes and other fees on your purchase.
Auto-buying site Edmunds suggests that, if you’ve been approved for a $30,000 loan, plan to reserve several thousand dollars of the amount to cover those extra expenses. You needn’t spend the money on any particular car or at any particular dealership. Instead, Edmunds suggests thinking of the pre-approval as a sort of “blank check” that isn’t limited to a certain car or dealer, and as approval to spend up to its allowed maximum.
You can then visit multiple dealerships and test-drive as many cars as you want before making a decision to buy. (Some lenders, though, have a list of approved car dealers, so make sure you verify that the dealerships at which you’re shopping are on it.)
If you’re shopping for a used car, additional restrictions will apply, beyond the need to buy from a franchised dealership rather than an individual or independent car lot. The maximum amount you can borrow may be capped, along with the age and mileage of the car. Capital One, for example, says borrowers can only finance a used vehicle for up to $40,000. The vehicle must be no more than 10 years old and have 120,000 miles or less on its odometer. With both new and used cars, your pre-approval can be used as a bargaining tool during negotiations with the dealer. For example, if the dealer is asking more than your pre-approved amount, consider using that gap as leverage to get a better price.
If the preapproval offers better terms than the dealer financing, consider offering to take a loan through the dealer in exchange for a lower price or some extras for free, such as accessories for a new car or a longer warranty for a used one. Once you’ve found the right car, and settled on a price, you hand over your pre-approval document. The dealer will then get in touch with your lender to arrange payment.
How to Get a Car Loan if You Have Bad Credit
It’s still possible to get a car loan if you have a checkered credit history, but you’ll naturally pay more in interest than if you had a higher credit score. Your list of likely lenders will also be shorter, and you may need to take steps that more creditworthy consumers can forego. (These tips will also be useful to those who lack any credit at all in the U.S., such as recent immigrants.)
There’s little to no hope of qualifying for the low- or no-interest offers touted in auto ads. Even in today’s low-interest-rate environment, car buyers with poor credit can expect an annual rate of between 10% and 20%, according to Experian in mid-September 2020. Banks are a less likely source of a car loan if your credit is damaged, since they are more conservative with risk than some other lenders. Credit unions can be more lenient about the financial history of those they lend to, and their rates can be much lower than some other lending alternatives for those with problematic credit scores. Those other options include dealers, often independents, who specify that they cater to buyers with bad credit. As Equifax says, such “buy-here-pay-here” sellers potentially profit from both the car sale and the loan, and so are often more flexible with their credit requirements. The agency warns, though, that such dealers may charge high interest, even compared with other lenders to the credit-damaged, and may require that monthly loan payments be made in person at the lot. Two other steps will increase the odds that those with poor credit will receive a car loan, and be able to manage it after they do so.
The first step is to seek a co-signer for the loan who themselves has a credit record that’s good or better. Keep in mind, though, that a co-signed loan broadens the impact of missed payments or a default beyond simply your own finances and credit record; you co-signer will be on the hook for those, and their own credit score will be damaged by any missteps.
The other step is to amass the largest downpayment you can. That will not only reduce the amount you need to borrow, and increase your odds of approval, but reduce your interest payments and the overall financial burden of the loan.
Manage Your Car Loan Responsibly
Keep in mind that, with a car bought with a loan, you don’t only own a new vehicle but a new financial obligation. Be careful, then, to make car payments on time. And if you will be late in a particular month, it’s best to contact the lender in advance, explaining the reason. If that reason is related to COVID, you may even be able to get an extension or set a new payment schedule.