Get Pre Approved for a Car Loan

The majority of consumers these days finance their vehicle purchases, and the many of them do so through the dealership F&I (finance & insurance) department where they are purchasing their new or used car. However, the Consumer Financial Protection Bureau (CFPB) has been telling consumers that dealer-arranged financing can result in higher interest rates than you deserve based on your credit, income, location, vehicle type, and other factors[1].

For this reason, it is often best to get your car loan pre-approved through a bank, credit union, or online lender before you set foot on the dealership lot. With pre-approved financing, you will enjoy similar benefits as if you were paying by cash or check:  better negotiating power, a more streamlined buying process, and potentially reduced financing fees.

Steps

  1. Check your credit report for errors or inaccuracies.  The FTC has found that 26% of consumers have at least one error on their credit reports, and 5% have errors that lead them to either be denied credit or pay higher rates of interest on financial products like auto loans[2]. For this reason, it is important to request your credit report, check it for errors, and dispute any errors you find.  The FTC has found that in about 50% of cases, this leads to an increase in one's credit score.
  2. Make certain you meet minimum auto lending requirements. Most banks, credit unions, and other lenders that pre-approve borrowers for financing require a minimum monthly pre-tax income of $1500, as well as a debt-to-income ratio (DTI) of 45% or less[3]. You may not be able to boost your income in the short term, but you can improve your DTI by paying off credit card debts and the like.
  3. Shop rates at local banks and credit unions. The various credit scoring models now take into account the practice of "rate-shopping," meaning the submission of multiple applications for the same type of loan in order to compare interest rates from various lenders. Depending on the scoring model being utilized, multiple credit inquiries within a 14-45 day period are only counted as a single inquiry[4]. Typically it is best to start with a bank or credit union with whom you have an existing relationship, then compare the rates offered with other lenders in your area. If you have a credit score of 680 or lower, you may need to consider alternative lenders that fund subprime auto loans.
  4. Take your "blank check" to the dealership.  Since you have not yet picked out the specific vehicle you want, many lenders will give you a "blank check" to bring to the dealer lot. In reality, this document pre-approves you up to specific, predetermined loan amount. Also, your vehicle will, most likely, need to meet specific guidelines in terms of age and mileage. For some major lenders, the limits are 7 years or 70,000 miles[5].  Once you choose your vehicle, you give your "blank check" to the dealer, and they finalize the lending arrangements with your bank, credit union, or finance company.
  5. Compare your pre-approved rate to what the dealer F&I offers.  Just because you were able to arrange your loan ahead of time doesn't guarantee that you were offered the very best rate. This is particularly true if you have very good credit, as many dealers work with "captive" finance companies that offer special low rate or even 0% financing. There is no harm in seeing what APR rate the dealer can offer you through its own network of lenders, as long as you keep in mind any added down payment requirements.
  6. Make certain you have full coverage insurance. All reputable auto lenders now require consumers to carry a full coverage insurance policy on the financed vehicle. This ensures that the at least part of the loan balance will be recouped in the event of an at-fault accident that totals the vehicle. If you provided a down payment of less than 20%, giving you a high loan-to-value ratio (LTV), you may also be required to carry GAP (Guaranteed Auto Protection) insurance[6]. This covers the difference between the amount the vehicle is worth as an insurance loss and the remaining balance on the loan.
  7. Drive your new car home. This is the fun part! With all of the paperwork handled, you can drive your vehicle home. Keep in mind that your bank or lender will have a lien on the vehicle's title until it is paid off, but the car is now, effectively, yours!

Tips

  • Your total transportation costs should account for no more than 18-20% of your monthly income. Your car payment itself should account for no more than 5-10%. This leaves enough room in your budget for fuel, maintenance, insurance, and other vehicle-related costs that arise throughout the month.
  • Providing a down payment of 10-20% will reduce the loan-to-value ratio (LTV) on your loan, thereby improving your interest rate. It will also militate against negative equity, which can turn into a big problem if your car is totaled, repossessed, or you trade it in before it is fully paid off.

Related Articles

Sources and Citations

  1. ↑ CFPB: Dealer-Financing
  2. ↑ FTC: Credit Report Accuracy Study
  3. ↑ Motive: Requirements for Pre-Approved Loans
  4. ↑ FICO: Rate-Shopping and Credit Inquiries
  5. ↑ Edmunds: Requirements for Financing Used Cars
  6. ↑ Bankrate: GAP Insurance Right for You?
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