Car loans are an important part of life for many, and if you have never gotten one before, the process can seem daunting. Here, we will break the process down into six steps to help you understand car financing.
Before we get into how to obtain a car loan, let's start with the foundation of what a car loan really is. Auto financing allows people to purchase cars by borrowing from lenders and paying the loan back with interest over a period of time. By issuing a car loan, lenders own the title to the car until they are paid back in full. If you default on your payments, lenders can repossess your vehicle and sell it to make up for their losses. This is why it is important to get the right loan for you – one you can afford to pay back and avoid default on. Financing a car can seem overwhelming, but following these steps can help ensure a headache free car purchase.
1. Know Your Credit Score
Credit is a measure that helps lenders assess your credit worthiness and is the main factor in determining the interest rate you will receive. A variety of factors are used to define your credit score including payment history and how much debt you have. You can check your credit score for free online and you can check your credit reports for free once a year.
Knowing your score will help you negotiate and avoid any surprises from potential lenders. The lower your score is, the more important it is for you to shop around to make sure you're getting the best possible rate for your credit score. If you do have a low score, it is possible to improve your credit, and you should attempt to do so to get the best available interest rate.
2. Understand the Total Cost of the Loan and How Much You Can Afford
Interest is the biggest variable in loan rates. There are a few strategies to keep the total interest you pay on the loan as low as possible. The first of these is the most obvious – to get the lowest interest rate you can. By having a good credit score and shopping around for loans, you can attain the lowest rate possible. The next way to keep total interest down is to put down the highest down payment you can afford. This will decrease the principal loan amount, which will decrease the total interest paid over the life of the loan. You should also try to keep the term as short as possible. While it is tempting to take out a longer loan for lower monthly payments, you will actually end up paying significantly more over the life of loan because you will be paying the interest more slowly.
You should also factor in more than just the sticker price of the car when thinking about your loan. You will want to consider other expenses of having a car, such as insurance, maintenance, and gas. If possible, you will also want to pay fees and taxes in cash when purchasing the car so they are not rolled into the price of the car, as this will increase the loan principal and the total interest you have to pay.
You can use calculators such as LendingTree's Auto Affordability Calculator below to help you decide how much car you can afford.
3. Shop Around for Your Loan
This is one of the most important steps in the process. You have spent time and effort shopping for your car, and you should do the same while deciding on your loan. This will allow you to find the best loan partnership, as well as give you bargaining power with other lenders.
You can utilize services such as LendingTree to compare multiple lenders at once. By inputting information such as your loan amount, you will receive personalized offers from a variety of lenders.
4. Get Preapproved
By getting preapproved for your car loan, you can lock in your interest rate and gain bargaining power with other lenders.
To get preapproved, you must complete an application which is reviewed by financial underwriters. Preapprovals come with an expiration date, typically within 30 days. If you do not use the preapproved loan before this time, the loan offer will expire. You will not owe the lender any money, the offer will simply cease to be available. Preapprovals allow you to shop based on the total amount of the loan that you have been approved for instead of monthly payments, and are typically calculated with registration fees and sales tax included. This will help keep you in budget as you car shop. They also typically cut down the amount of time spent haggling with dealerships and help you avoid unnecessary markups.
5. Apply for the Loan
If you did not utilize your preapproved loan, it is time for you to apply for your loan. Loan applications typically ask for information such as your contact information, annual income and proof of income, credit and banking history, proof of residence, Social Security Number, loan amount, and vehicle and insurance information (if applicable).
If you are putting in applications with multiple lenders, you should attempt to do so within a two-week period. Every time you apply for a loan, your credit score decreases slightly. By keeping all of your applications within a two-week window, all the inquiries will only reflect as one inquiry on your credit report.
6. Close the Loan and Make Payments
You should thoroughly read the conditions of your loan before you sign on the dotted line and be on the lookout for policies such as prepayment penalties. Once you start paying off your loan, it is important that you make your payments in full and on time. If you think you will be late with a payment, let your creditor know as soon as you do. Keeping your creditor in the know could potentially keep credit score decreases to a minimum and will keep your lender happy.
You did it! Congrats on your new loan and car purchase.