Did you know that transportation is the average American’s second biggest expense? That’s why many choose to finance their cars instead of buying them outright.
But qualifying for a car loan can be challenging—especially if you’ve never done it before. So, if this is your first time getting a car loan, follow these steps:
1. Set a budget
Before you apply for car loans, set a budget. This helps ensure you don’t get a loan you can’t afford. Take a look at your regular income and expenses. Then factor in a car payment. Don’t forget to account for other car-related expenses, such as gas, maintenance, car insurance, and unexpected repairs. Together with your car payment, these should make up no more than 20% of your take-home pay.
2. Check your credit report
Next, check your credit report. It provides your credit score and credit history, which can have a major impact on the interest rate of your car loan. You can get a free credit report every year at www.annualcreditreport.com.
Look for any errors, such as inaccurate or outdated information or unrecognized accounts. These could hurt your score so correcting them could improve it.
If your credit score is below 600, it’s considered poor. Consider taking time to increase it before applying for a car loan by making payments on time and maintaining a low credit utilization rate. You want to clean up your credit report as much as possible.
3. Gather necessary documents
To apply for a car loan, you’ll need to present the lender with certain documents. These include personal information (name, address, phone number, etc.), proof of income (employer letter, tax returns, pay stubs, etc.) and, if you have a vehicle picked out already, vehicle information (make, model, age, mileage, VIN number).
Lenders will use this information to determine what type of loan they will offer and at what interest rate.
4. Shop around for car loans
Once you have the appropriate documents gathered, you can start shopping around for car loans. Apply at multiple lenders and compare quotes.
Look for the lowest interest rate since even a slight percentage difference can make a huge difference in the overall cost of the loan. But also pay attention to loan terms. Do your research and see which loan best suits your needs.
5. Get preapproved for an auto loan
Many lenders will preapprove you for a car loan after reviewing your application documents. This is different from getting prequalified, where the lender qualifies you for a loan based on self-reported information.
Preapproval means a lender is willing to offer you a loan (for a certain amount by a certain date) based on a thorough assessment of your finances. It’s a stronger commitment by the lender and is therefore taken more seriously by sellers. It may give you more leverage when negotiating a deal. So, get preapproved for a car loan if you can.
6. Use your loan offer to adjust your budget
Of course, a loan offer will set natural parameters for your car budget. It gives you a maximum limit for how much you can spend.
That doesn’t mean you must take out a car loan for the full amount. First of all, you’ll want to set aside at least 10% of the loan amount to cover taxes and fees. But also, don’t feel like you need to buy a car that costs the remaining 90%. Take out whatever size loan you are comfortable with. Adjust your budget accordingly.
7. Review the dealership’s loan offer
Another option to consider is dealership financing, aka buy-here, pay-here (BHPH) financing. Many dealerships offer this, so you don’t have to worry about finding a car loan on your own. According to Tiger Okeley at BHPH dealership Oak Motors, “Buy-here, pay-here dealerships often have looser lending requirements and therefore may be a good option for those with credit challenges.”
You can always go to a dealership with a preapproval letter from another lender to see if they will match or beat it.
Lastly, buy-here, pay-here financing is a great way to rebuild your credit if that’s something that’s applicable to you.
8. Finalize your car loan
Ultimately, the goal is to find the best car loan for your situation. There isn’t one lender or loan that’s best for everyone. Get lenders to compete for your business and see where you can get the best loan terms.
If you go with the preapproved loan offer, follow the lender’s instructions to complete the loan application. Whatever you do, don’t sign under the dotted line until you do your due diligence and verify loan terms, fees, and policies.