Purchasing a new or used car is an exciting experience, whether it’s your first car or you’re upgrading to your dream car. Part of the car buying process involves deciding how you’ll pay for the vehicle. Because cars are a major expense, most car buyers finance some or all of the vehicle’s cost with an auto loan.
Getting an auto loan is a relatively straightforward process, but if you’ve never taken out a car loan, it’s important to understand how it works and what to expect. In this guide, we’ll explain how to apply for an auto loan, step-by-step.
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What Is an Auto Loan?
An auto loan is one method of financing a car purchase. You borrow money from a lender, like a bank or credit union, which is used to buy a used or new car. In exchange for the money, you agree to pay the full amount back, plus interest, over a specific time frame (usually between 24 and 72 months).
Until the auto loan is paid off in full, your lender legally owns the vehicle. If you stop making the payments, the lender has the authority to repossess your vehicle as collateral. Once the loan is paid, you become the legal owner and can sell or trade in the car whenever you want.
Determining Your Budget
Before you start shopping for a new or used car, it’s a good idea to figure out how much car you can afford.
Most financial experts recommend spending no more than 10 percent of your take-home pay on a monthly auto loan payment. You can also use an auto loan calculator to figure out how much you can afford to spend on a car.
Once you’ve determined your price range, you should research what taxes and fees you’ll need to pay as part of the transaction. Taxes and fees depend on the state where you’re buying the car, whether it’s new or used, and whether you’re trading in a vehicle as part of the transaction.
How to Apply for a Loan
Applying for a car loan isn’t complicated, but there are a few things you can do to simplify the process. Here are the steps you should follow if you want to take out an auto loan:
1. Compare Lenders
Before you submit a loan application, take some time to compare different lenders. You might start with your bank or credit union, as an established relationship can help you qualify for a better rate.
It’s also smart to look at online lenders and financial institutions, as they might charge fewer fees due to lower overhead costs. A dealership can also provide financing for cars purchased at their location.
When comparing lenders, make sure you’re looking at similar loans. For example, start by comparing terms for a $15,000 loan over 60 months. See what interest rates different lenders charge, and what discounts are available.
It’s also important to assess potential loans for any hidden fees, add-ons, and other extra costs. These can cause your monthly payment to increase substantially and could make it harder to afford the car you want.
You should also see if the lender assesses a penalty for early payment. This isn’t ideal, because it limits your ability to pay off the loan early, which can help you avoid high interest fees.
2. Check Your Credit
Your credit history and credit score affect your ability to qualify for a car loan, as well as the interest rate you receive. Some auto lenders offer financing to borrowers with lower credit scores, but these loans usually come with higher interest rates and less favorable terms.
Before you start applying for loans, check your credit so you know what to expect. A good credit score is usually 661 or higher. You typically need a score of at least 500 to qualify for a car loan at all.
If your score falls below the minimum requirement, you’ll probably have to work with a lender offering subprime loans or a loan program for car buyers with poor credit.
3. Improve Your Credit Score
If your credit is low, consider taking steps to improve your score before applying for a car loan. Paying down your debt, going through the debt consolidation process, and making on-time payments can all help you improve your score. Decreasing your credit utilization amount can also boost your credit score.
4. Determine Your Down Payment
When you buy a car, you typically have to pay a portion of the total cost in cash. This is called the down payment. Some lenders have strict down payment requirements, such as a percentage of the purchase price. Others allow buyers to choose their own down payment amounts.
The bigger your down payment is, the less money you’ll have to borrow. This reduces the risk to the lender and helps you get a lower monthly payment.
Figure out how much you can afford to pay in cash at the time of purchase. You’ll need to provide this number when applying for a loan. If you don’t have anything to put down, you might want to save up some money, as it’s harder to qualify for a loan with no down payment.
5. Get Pre-Qualified
The next step in applying for a car loan is getting preapproved. An auto loan preapproval or pre-qualification is a tentative offer for financing based on the information you give the lender. Although it’s not a guarantee, getting preapproved can help you establish a firmer budget, and it shows sellers that you’re a qualified and serious buyer.
Obtaining pre-qualification for a car loan involves filling out a lender’s application and providing basic financial and personal information. The application might request information like:
- Your name and contact information
- Your Social Security number
- Details about your employment situation and income
- How much you pay for housing each month
- What vehicle you’re interested in buying
Most lenders allow you to submit an application online. You might also have to provide certain documents when you finalize the loan, such as your driver’s license and proof of insurance.
The loan preapproval process usually involves a hard or soft inquiry on your credit report, depending on the lender’s process. Before you submit an application, check what type of inquiry the lender will use.
A hard inquiry can cause your credit score to dip. However, multiple hard inquiries on your credit within a short time frame count as one inquiry, so try to apply with all potential lenders within a day or two.
6. Submit Multiple Applications
Submitting applications to multiple lenders can help you get the best rate. Not all lenders offer financing for all car purchases, so be sure to take these requirements into consideration.
For example, if you’re buying from a private seller, you probably can’t get financing through a car dealership. If you plan to buy from a dealer, it’s still worth looking at the annual percentage rate (APR) options and loan terms offered by a large national bank or a community bank, as you might be able to use other offers as leverage.
7. Start Car Shopping
After getting your preapproval, it’s time to start car shopping. Your preapproval amount is the maximum you can borrow, so deduct about 10 to 15 percent to get the amount you can afford to spend on a car. Review any restrictions that might apply to your car loan, such as:
- Excluded brands: Some lenders exclude certain auto brands or vehicle types from lending options.
- Buying time frame: A lender might offer 30 or 60 days to complete the financing process, and if you fail to do so within the time frame, you have to start over with a new preapproval.
As you compare cars, look at online and in-person dealerships. You can also use sites like eBay Motors, Craigslist, and Facebook Marketplace to see cars from private sellers in your area.
8. Do a Final Comparison
If you find a car to buy at a dealership, it’s smart to make a final comparison between the lender you’re pre-qualified with and financing offered through the dealership.
Most automotive manufacturers have their own financial institutions, and they might be able to offer lower rates than other lenders. This is especially true if you’re buying a brand-new car.
Your pre-approval letter can come in handy here. Show the dealership’s finance department what you previously got pre-qualified for and see if they can beat that rate. To get an offer from the dealership, you’ll need to submit another application with your personal and financial details.
9. Finalize Your Loan
After choosing your car and doing a final comparison between the lenders, the last step is to finalize the loan and purchase the car. Depending on your lender, you might receive the funds directly, which you can then use to purchase the car. If you get financing through a dealership, the funds go directly from the lender to the dealer.
Most private sellers require buyers to use a cashier’s check or cash for security purposes. If you’re buying from a private seller, talk to your loan officer or representative to find out how to complete the transaction and get the money for the car.
10. Set Up Payments
You typically have about a month or so between finalizing the loan and when your first payment is due. During the loan process, confirm the due date of the first payment and determine how you’ll make the payment each month. Some lenders offer auto pay, where the payment automatically gets deducted from your checking account every month.
Whatever you decide, set it up right away to avoid missing a payment or submitting it late. Failing to pay on time can affect your credit and lead to potential fees.
Finance & Insurance Editor
Elizabeth Rivelli is a freelance writer with more than three years of experience covering personal finance and insurance. She has extensive knowledge of various insurance lines, including car insurance and property insurance. Her byline has appeared in dozens of online finance publications, like The Balance, Investopedia, Reviews.com, Forbes, and Bankrate.
