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How Do You Qualify for a Car Loan?

Joan PabonDec 13, 2017

If you’re looking to buy a new car but don’t have sufficient funds to cover the entire purchase, you may be considering different auto financing options. Before starting your search, calculate how much you can afford to pay each month and, if you’re able to, set aside at least 10% for a down payment.

How to Qualify for a Car Loan

  • Determine What You Can Pay Monthly
  • Get Your FICO Score
  • Identify Type of Vehicle You Can Realistically Afford
  • Calculate Down Payment
  • Seek Pre-Approval

When looking to finance an automobile, the first thing you will need to do is calculate how much you'll be able to pay towards a loan each month. Be honest with yourself and factor in other expenses, such as utility payments, credit card debt, mortgage payments, and any other financial responsibility. After defining your limits, evaluate your credit history by requesting a free annual credit report and disputing any incorrect and potentially detrimental information. If you can, try to obtain your FICO score, as this is the credit score model the majority of lenders use to calculate the risk of lending to consumers. Once you have a good idea of your credit standing, identify the type of vehicle you want to purchase including its make, model, and year. Keep in mind that the condition and age of the car can increase both auto loan interest rates and insurance premiums.

Most banks, credit unions, and lending institutions look up the Kelley Blue Book retail value of any given vehicle to determine how much they would be willing to lend towards its purchase. Look up such details yourself and set aside at least 10% of the car's value for closing costs. If you’re looking to buy a used car valued at $10,000, for example, aim to have at least $1,000 saved up for your vehicle's down payment. Some lenders may require larger down payments for new vehicles to offset their depreciation, which means you may have to look for a lender willing to grant you more than 100% of the car's value. We don't recommend you take on a loan with no money down, however, as a larger loan amount would mean higher monthly payments and overall interest charges. If you have an older car that's already paid for, consider a trade-in, as it can help you offset the cost of a down payment. Once you know what you can expect from a lender with regards to the down payment and processing fees, seek pre-approval from small banks and credit unions in your area.

How to Apply for a Car Loan

  • Determine How Long You Plan to Have the Vehicle
  • Calculate Loan Terms
  • Compare APRs

When you apply for pre-approval, most lending institutions will scrutinize your income, employment history, assets, and debt along with your credit score to determine how likely you are to become delinquent on a loan. A healthy credit score of 710 or higher is sure to secure you a good interest rate and loan terms, but lenders may still be willing to work with a slightly lower score if you have savings or other assets. Before signing up for a long-term agreement, consider for how long you plan on keeping the vehicle you want to purchase and how long it will take you to pay off the loan, as it will depreciate over time and you may end up paying more than the car is worth. Also look at the annual percentage rate, which is the cost of the credit charged over the life of the loan, and compare different options. Remember that interest rates are higher for used vehicles than for new ones, and that shorter loan terms are generally better, because the longer you take to pay off the loan, the greater the interest charges will end up being.

Lease vs. Loan

Instead of paying for the vehicle in its entirety, another option you may want to consider is leasing. Leasing a car is not unlike renting it, but you will be required to pay a deposit in addition to an agreed number of monthly payments based on how much the car will be worth when you return it. Since leasing accounts for the vehicle's depreciation and you are only paying for the portion of the car's value you use during the term of the agreement, monthly lease payments tend to be lower than loan repayments. At the end of your lease, you have the option of purchasing the car at the value predicted by the lender at the beginning of the agreement or exchanging it for a new one. Besides lower monthly payments, leasing also offers the advantage being covered by a car warranty that protects you from having to shoulder expensive repairs. However, when you lease a vehicle you are still responsible for mileage overages as well as excessive wear and tear fees and high insurance rates. Leasing works best for those who drive a car for business and want to be able to have a new model every couple of years. Still,  since you don't have unending payments and the vehicle is yours to keep at the end of the term, financing ends up being a cheaper option in almost every case.

If you're set on taking out an auto loan, shop around and compare interest rates from different lending institutions. Also look into the benefits of purchasing a car from a private party, but don't forget to take the vehicle to your own trusted mechanic for inspection and opt to pay with a check or money order instead of cash. Once you have a few different options on the table, use an online auto loan calculator to compare rates, terms, and finance amounts. Remember you can negotiate the terms of the loan if you have opted for dealership financing, so don't settle for a high interest rate and unfavorable terms when you can get a better deal through bargaining. Finally, look into different auto insurance options and compare rates. Since your car will be the bank's collateral, they will want to make sure it's well protected with liability, collision, and comprehensive coverages.