The auto loan is the financing instrument you use to pay for a vehicle. It can be obtained from a direct lender (like banks, credit unions and online lenders) or at the dealer where you purchase the car.
Lenders typically approve loans based on a number of factors, including your credit scores, income, debt levels and employment history. You may be able to get preapproved for an Auto Loan before you begin shopping, which can help you identify a target range of vehicles and make more informed buying decisions.
In general, higher credit scores generally mean lower interest rates. If your credit score is below average, consider applying with a cosigner or researching lenders that specialize in helping buyers with bad credit. It’s also important to think about the size of any down payment you might be able to afford to contribute toward the new vehicle, which can impact your total monthly payment and loan term.
Whether you’re obtaining an auto loan directly from a lender or through the dealership, the loan approval process is fairly similar. You’ll need to provide proof of identity, residence and income. In most cases, you’ll also be required to have a minimum down payment of 10% of the vehicle price. Lenders also usually prefer borrowers with a debt-to-income ratio that’s no more than 50%.
The lender will determine the maximum amount you can borrow, based on your financial profile and the car price you’re targeting. You can then shop around for the best available auto loan terms. To make apples-to-apples comparisons, be sure to look at the annual percentage rate (APR) for each option, which includes both interest and fees.
Once you find a car that meets your needs, the lender will disburse funds to the dealer, which in turn pays the seller. You’ll then take possession of the vehicle and make regular payments to the lender over the loan term.
Some borrowers opt for a longer loan term, which can reduce monthly payments but ultimately increase the cost of the vehicle over time. Keep in mind, though, that cars can quickly depreciate in value, meaning you could end up owing more on the loan than the car is worth if you’re not careful.
Dealerships often offer manufacturer-sponsored low-rate or incentive programs, which can be an attractive option if you’re ready to buy and don’t want to wait for your lender to provide financing. However, dealer-sourced financing can often carry higher interest rates than a traditional lender’s.
If you decide to pursue dealer financing, make sure to negotiate for the lowest possible rates. In addition to asking for a better APR, you might be able to snag a lower rate by offering a larger down payment or shorter loan term. You can also use an online lender or aggregator to compare the terms of multiple dealer-sourced or traditional auto loans before choosing one. You should also be on the lookout for “buy here, pay here” dealers that have in-house finance departments and offer high-interest loans to people with subprime credit ratings.