Buying 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 includes deciding how to pay for the vehicle. Because cars are a major expense, most car buyers finance part or all of the cost of the vehicle with a car loan.
Getting a car loan is a relatively simple process, but if you’ve never taken out a car loan before, it’s important to understand how it works and what to expect. In this guide we explain step by step how to apply for a car loan.
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What is a car loan?
A car loan is a way to finance the purchase of a car. You borrow money from a lender, such as a bank or credit union, that is used to buy a used or new car. In exchange for the money, you agree to repay the full amount plus interest over a specified period of time (usually between 24 and 72 months).
Until the car loan is paid off in full, your lender legally owns the vehicle. If you stop paying, 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.
Determine your budget
Before you start shopping for a new or used carit is a good idea to find 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 car loan. You can also use a car loan calculator to find out how much you can afford to spend on a car.
Once you’ve determined your price range, you’ll need to research what taxes and fees you’ll need to pay as part of the transaction. Taxes and fees depend on the state where you buy 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 to follow if you want to take out a car loan:
1. Compare lenders
Before submitting a loan application, take some time to compare different lenders. You can start with your bank or credit union, as a steady relationship can help you qualify for a better rate.
It’s also smart to look into online lenders and financial institutions as they may charge less due to lower overheads. A dealership can also provide financing for cars purchased at their location.
When comparing lenders, make sure that you look at comparable loans. For example, start by comparing terms for a $15,000 60-month loan. See what interest rates different lenders charge and what discounts are available.
It is also important to review potential loans for hidden fees, add-ons, and other additional costs. These can cause your monthly payment to increase significantly and can make it more difficult to afford the car you want.
Also see if the lender charges a prepayment penalty. This is not ideal, as it limits your ability to pay off the loan early, helping you avoid high interest costs.
2. Check your credit
Your credit history and credit score affect your ability to qualify for a car loan, as well as the interest you receive. Some car borrowers offer financing to borrowers with lower credit scores, but these loans usually have 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 usually is 661 or higher. You typically need a score of at least 500 to qualify for a car loan.
If your score falls below the minimum requirement, you’ll probably have to work with a lender that offers subprime loans or a car buyer loan program with bad 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 off your debt, going through the debt consolidation process, and paying on time can improve your score. Lowering your credit utilization amount can also raise your credit score.
4. Determine your down payment
When you buy a car, you usually have to pay part of the total costs in cash. This is called the down payment. Some lenders have strict requirements for the down payment, such as a percentage of the purchase price. Others let buyers choose their own down payment amounts.
The larger your down payment is, the less money you have to borrow. This reduces risk to the lender and helps you get a lower monthly payment.
Find out how much you can afford to pay in cash at the time of purchase. You will need this number when applying for a loan. If you don’t have anything to spend, you may want to save some money since it’s more difficult to qualify for a no-down loan.
5. Get pre-qualified
The next step in it apply for a car loan is approved in advance. A car loan pre-approval or pre-qualification is a preliminary offer for financing based on the information you give the lender. While it’s not a guarantee, getting pre-approved can help you establish a firmer budget, and it shows sellers that you’re a qualified and serious buyer.
Getting pre-qualified for a car loan involves completing a lender’s application and providing basic financial and personal information. The application may ask for information such as:
Your name and contact details
Your citizen service number
Information about your work situation and income
How much you pay each month for housing
Which vehicle you want to buy
You can submit an application online with most lenders. You may also be required to submit certain documents when taking out the loan, such as your driver’s license and proof of insurance.
The loan pre-approval process usually includes a hard or soft examination of your credit report, depending on the lender’s process. Before applying, check what type of research the lender will use.
A difficult research can cause your credit score to drop. However, multiple hard inquiries into your credit within a short time frame count as one inquiry, so try to apply to 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 keep these requirements in mind.
For example, if you buy from a private seller, you probably won’t be able to get financing through a car dealership. If you’re planning to buy from a dealer, it’s still worth looking into the annual percentage rate (APR) options and loan terms offered by a major national or community bank, as you may other offers as leverage.
7. Start car shopping
After you get your pre-approval, it’s time to start car shopping. Your pre-approved amount is the maximum you can borrow, so subtract about 10 to 15 percent to get the amount you can afford to spend on a car. Review any restrictions that may apply to your car loan, such as:
Excluded Brands: Some lenders exclude certain car makes or vehicle types from lending options.
Buy time frame: A lender may offer 30 or 60 days to complete the financing process, and if you don’t do it within the time frame, you’ll have to start over with a new pre-approval.
When comparing cars, look at online and in-person dealerships. You can also use sites like eBay Motors, Craigslist, and Facebook Marketplace to view cars from private sellers in your area.
8. Make a final comparison
When you find a car to buy from a dealer, it’s smart to make a final comparison between the lender you’re pre-qualified with and the financing offered through the dealer.
Most automakers have their own financial institutions and may be able to offer lower rates than other lenders. This is especially true if you are buying a brand new car.
Your pre-approval letter can come in handy here. Show the dealer’s finance department what you’ve previously qualified for and see if they can beat that rate. To get an offer from the dealer, you need to submit another application with your personal and financial information.
9. Complete your loan
After choosing your car and making a final comparison between the lenders, the last step is to finalize the loan and buy the car. Depending on your lender, you may receive the money directly, which you can then use to buy the car. If you get financing through a dealer, the money goes directly from the lender to the dealer.
Most private sellers require buyers to use check or cash for security purposes. If you are 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 usually 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 will make the payment each month. Some lenders offer automatic payments, where the payment is automatically debited from your checking account each month.
Whatever you decide, set it up right away to avoid missing a payment or submitting it late. Failure to pay on time may affect your credit and lead to potential charges.
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