Purchasing a vehicle is likely to be one of the bigger financial decisions you’ll make in your life. According to Lending Tree, Americans take out about $56 billion in auto loans each month. Before you add to this statistic, car-buying experts recommend researching your loan options first — and finding the car you want second. Arming yourself with the knowledge of how much you can afford to spend before you hit the sales lot will expedite the car buying process and save you a few headaches, and maybe a few dollars, along the way.
In order to secure an auto loan with the best possible interest rate, it’s important to understand where you are financially, as well as what to look for when shopping around for loan offers.
Read on to get a quick, easy rundown of the steps you’ll need to take to get a car loan.
Step 1: Figure Out How Much Car You Can Afford
Before putting any ink to paper, you’ll want to consider the total monthly costs. This number includes the car loan payment, insurance, and, of course, gas and maintenance. Be sure to take any other monthly debt obligations, such as student loans or credit cards, you have into account.
You’ll want to make sure that your debt-to-income ratio is around 40% or lower, as this can be a number that lenders take into account when considering your application.
Step 2: Check Your Credit Score
Before diving into any major purchase, it’s smart to check your credit reports. Knowing your credit score will give you an idea of what interest rates and loan terms you might qualify for. Of course, the better your credit score, the better those terms will be.
While looking over your credit report, it’s a good idea to look for any errors or any other issues that may be adversely affecting your credit score. Luckily, there are a lot of reputable sites that allow you to check your credit for free, without it impacting your score.
According to Experian, a FICO score of 670 or higher will net you the best terms for an auto loan. If it’s in the fair range, they say you’ll likely still qualify, but you may have to accept higher interest rates and/or a higher down payment.
Step 3: Shop Around For Loans from Multiple Lenders
It’s common for car dealerships to submit applications to multiple lenders in the hopes of finding you the lowest interest rate and most favorable loan terms. This is also something you can do on your own. Keep in mind that every time you apply for credit, a hard inquiry appears on your credit report. Too many hard inquiries can negatively affect your credit score. FICO usually lumps similar hard inquiries that occur within a short period of time, treating them as a single inquiry, and thereby reducing their impact on your credit score.
There are several different routes you can take to obtain a lender for an auto loan:
- Credit unions and banks. A financial institution is a straightforward option, especially if you already bank there. Credit unions typically offer lower interest rates and fees than banks.
- Car dealers. Financing through the dealer can be convenient, and may provide you with access to special incentives and deals. This could be a good option for those who have good credit.
- Online lenders. There are many online lenders that provide auto loans. These loans typically work similarly to lending from a bank or credit union. Some websites enable you to get quotes from multiple lenders at once. Be aware that Consumer Reports warns that filling out a form with an online lender can result in being inundated with phone calls and emails, and the loan may wind up having higher fees than the other options. Be sure to pay attention to the fine print and ask lots of questions.
Step 4: Get Pre-Approved
Now that you’ve made it through the research process, it’s time to secure a loan commitment (or several).
If you decide to go with a financial institution, you can get pre-approved. Pre-approval for a car loan usually involves completing a preliminary application with a lender, who then reviews your credit and other financial information. They’ll let you know the amount of the loan they’ll finance, and the interest rate they’re likely to offer.
Getting pre-approved can help you find the best interest rate, and you’ll know exactly how much you can spend, which will give you bargaining power with the dealership. Just remember to complete the pre-approval and actual loan application within a short period of time, in order to minimize the potential impact of hard inquiries on your credit score.
Step 5: Find Your Car
Now that you know exactly how much car you can afford, it’s time for the fun part: picking out your new wheels.
Keep in mind that your pre-approval offer states the maximum amount you can borrow, but that also includes taxes and fees. Also, some lenders have a list of approved car dealerships and/or excluded brands, so make sure to verify that information before you get your heart set on a particular car. Shopping for a used car will come with additional restrictions, e.g. mileage or age of the car.
Once you’ve found the right car — for the right price — hand over your pre-approval document, and your dealer will contact your lender to make arrangements.