Buying a new car is exciting when you’re deciding on what you want, picking the color, and testing out all the cool new features. Getting a car loan, on the other hand, can feel a lot less exciting—and a whole lot more complicated.
As tempting as it may be to skip over the details and skim the fine print, accepting the first loan you’re offered can cost you more in the long run. Before you head to the dealer, get familiar with the ins and outs of car loans so you can make a more confident—and cost-saving—decision.
As with any financing arrangement, there are a few things to know before taking out an auto loan.
You can get a car loan directly from an online lender, bank, or credit union. If you’re buying a car from a dealership, you can also choose dealer financing. With this option, the dealer arranges financing for you though a third-party lender or the dealer providers financing directly.
Dealerships sometimes offer low introductory APRs or rebates to entice borrowers, but they may have higher rates over the long term than other options. Savvy borrowers often shop around with several lenders before heading to the dealer to ensure they get the best auto loan rate.
You may have fewer options if you’re looking for a used car, especially when you’re purchasing a vehicle from another person rather than a dealership.
Lenders typically have minimum and maximum loan amounts. For used vehicles, lenders may also have a minimum required loan-to-value (LTV) ratio, meaning the loan amount shouldn’t be much higher than the car’s market value (if at all).
Even when it’s not required, making a down payment could help you qualify for more favorable loan terms. If you’re selling or trading in your existing vehicle, you can apply that money toward a down payment.
Lenders offer different rate ranges and typically advertise the best annual percentage rate (APR) for their auto loans, which may only be available to car buyers with excellent credit. Your specific loan offers and rates will depend on your credit, finances, the vehicle, and the lender.
Online lenders, banks, and credit unions may all offer loans. In most cases, prequalifying for a loan doesn’t require a hard credit check and gives you time to shop around and compare loans without committing to an offer.
Some lenders might charge a fee if you want to pay off your auto loan early. If the loan doesn’t have a prepayment fee or penalty, you may save money refinancing the loan or paying it off early.
These steps can help you get the best rate on your loan and the best deal on your purchase.
Review your credit report and scores to see where you currently stand. Look for ways to improve your credit—like paying down revolving account balances—before applying for an auto loan. Also, look for and dispute errors in your credit reports that may be hurting your scores.
You can get a free copy of your credit report from each of the major credit bureaus—Experian, Equifax, and TransUnion—once every 12 months. Because of the financial complications brought on by the pandemic, you can get weekly reports of your credit report for free through April, 2022.
Use an auto loan calculator to see how much you may be able to afford to borrow. Longer loan terms can help lower your monthly payment, but may increase your total cost over the life of the loan. Alternatively, shorter loan terms might be cheaper overall, but you’ll need to make sure you can afford the monthly payments.
And don’t forget additional costs that come with owning a vehicle—like gas, insurance, and registration.
When you’re ready to buy your vehicle, you can apply for loans that require a hard credit check. Multiple hard inquiries from auto loans that occur within a 14-day period typically don’t hurt your credit scores more than a single hard inquiry.
Keep in mind: While you may be able to get financing offers at a dealership, dealer-arranged financing is often more expensive. Many car dealers make money on the financing arrangement—with you paying the extra cost.
Once you have an auto loan offer in hand, you can head to a dealership or reach out to sellers. Use your budget and the results from the loan calculator (plug in your best loan offer) to determine how much you can spend.
Remember, cars are priced to leave room for negotiations. If you receive a loan outside the dealership, you’ll be negotiating as if you’re a “cash buyer,” which might give you an edge.
After agreeing on a price, you’ll need to complete all the paperwork to purchase the vehicle. The actual financing process can vary depending on the lender—so make sure you take the time to confirm the details.
Some lenders may be able to send the money directly to the sellers. If you’re buying a car from a private party, your lender may make out a check to the seller or lienholder. Once you take out the loan and hand over the money, you’ll need to start making your loan payments.
Getting a vehicle loan can be more difficult if you’re working to improve your credit scores, but there are financing options available. Once you improve your credit, you may be able to refinance your auto loan to get a lower interest rate or monthly payment.
Some lenders and car dealerships advertise loans specifically for those with less than perfect credit. While these loans can be an option, don’t automatically assume it is your only option. Compare loans with several online lenders to make sure you’re getting the best deal possible.
Lenders may let you add a cosigner to your auto loan application. A creditworthy cosigner could increase your chances of getting approved or the rates and terms you’re offered. However, they’re legally on the hook if you can’t afford the loan payments. If you miss payments or default on the loan, both of you will be impacted.
It may be easier to get approved for a smaller loan. While it might not be your top choice, a less-expensive car or one with fewer add-ons might be a good option. You could also look for a used vehicle, including certified pre-owned vehicles, which may come with a warranty. Negotiating with a private seller may help you get the best deal, but watch out for vehicle sale scams.
Similarly, you may be able to take out a smaller loan if you can save up for a large down payment. There are many ways to save money, but this could be difficult if you don’t have a lot of time before you need to buy a new vehicle.
Some dealerships offer “buy here, pay here” loans that don’t require good—or any—credit. It may be an option. However, the loans may have high fees or interest rates. You also may be limited to purchasing certain vehicles on the lot and may need to make a large down payment to qualify.
Qualifications can vary depending on the lender and the vehicle you’re buying. In general, having good credit, a low debt-to-income ratio, and a low loan-to-value ratio can increase your chances of getting approved.
A car loan can affect your credit score in different ways. Applying for and taking out a new loan could lead to a hard inquiry and lower your average age of accounts, which could hurt your credit. However, the new loan may positively increase your credit mix, and repaying the loan on time could help your scores.
The best way to get a car loan is to shop for a loan from several lenders to see which offers you the most favorable terms. If you don’t need a car loan right away, you could try to improve your credit or financial situation before applying.
You may need to agree to a credit check and show copies of documents that prove your identity, income, and residency to get a car loan. Additionally, you’ll need to share information about the vehicle. You may also need proof of auto insurance before a dealership will release the vehicle for you to drive home.
Banks may specialize in offering loans to different types of consumers or for different types of vehicles. As a result, there’s no single best bank, credit union, or lender. Your best option may be to shop around for an auto loan to find what’s best for your financial situation.