Some important things to do before you apply for a car loan

Group of happy people enjoying road trip in their convertible Image: Group of happy people enjoying road trip in their convertible

In a Nutshell

Sure, you can walk onto almost any “buy-here-pay-here” car lot and buy a car with whatever financing the dealer offers. But there’s a good chance that doing that means you’ll end up paying more for the loan than you have to. Instead, taking some preparatory steps could help you save the next time you need to apply for a car loan.

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When you apply for a car loan, you’re really getting two things: the car itself and the loan for your new vehicle.

Some people may look at a car loan’s monthly payment and overlook the total cost of financing. But by taking steps to shop around for the best all-around car loan terms for you, you may be able to save hundreds or even thousands of dollars by the time you pay off your loan.

Sure, it may not be your idea of a fun Friday night, but shopping around for a few hours to save big bucks could effectively be the same as paying yourself an uber-high hourly wage for the time you put in. And who wouldn’t want that?

Confused on how to apply for an auto loan? Let’s look at some steps to take when you’re looking for a loan. Ready? Fasten your seat belt, and let’s go.


Determine your budget

If you walk straight onto a car lot with nary a thought about the price, the first thing a car dealer may ask is, “What’s your monthly budget?” They’ve got a good reason to do so. If you’re focused on just how much car you can get for the monthly payment you feel you can afford, you may overlook the fact that your loan is for a longer term than you wanted. That longer term may mean a lower monthly payment, but you’ll make more of them — and probably pay more interest — than you would have with a shorter-term loan.

Instead, a better way to approach a car loan is to focus on the overall cost of the car — i.e., the final price tag, including total number of payments and interest you’ll pay. That way, you’re comparing apples to apples while you shop around, and you’re not letting a dealer “pack” your loan with unnecessary features that might fit your monthly budget, but could have you paying more in other ways, say with a longer loan term.

FAST FACTS

How do I run the numbers to see how much car I can afford?

There are a lot of factors that can determine how much car you might be able to afford, such as the car loan’s term, what interest rates you might qualify for, how much down payment you have, etc. The Consumer Financial Protection Bureau’s auto loan worksheet or an online car loan calculator may help you decide how much car you can afford to buy.

Check your credit scores and reports

It’s a good idea to check your credit scores and reports before you apply for a car loan.

If you have poor credit, you’ll probably qualify for higher rates than if you had better credit. You’ll have to decide whether to proceed with getting a car loan, or whether it’s a better idea to wait and work to improve your credit first.

If you already have excellent credit, congratulations! You may be able to use your good credit as a bargaining chip with lenders to negotiate better terms on your car loan.

FAST FACTS

How can I improve my credit?

There’s no quick-and-easy path to better credit. In fact, it can take a while to establish your credit. But if you need a car sooner than later, taking some of these steps could help improve your overall credit and may get you further than you think.

1. Pay down debt (especially high interest debt, like credit card debt)

2. Ask your credit card company to raise your credit limit (and don’t spend up to it!)

3. Keep your existing credit cards open as you continue to pay down their balances

4. Become an authorized user on a responsible friend’s or family member’s credit card

Shop around for car loans

Start collecting quotes

Now that you have a better idea of where your credit stands and you know what size loan you can afford, you may be ready to start shopping around for rates.

Three of the main places to apply for a car loan include …

Your task now is simple: Visit, call or check the websites of a number of banks and credit unions to ask for a quote. You can check out some options on Credit Karma.

Take note: Credit unions may offer car loans at better rates than big banks. According to the National Credit Union Administration, as of late June 2018 credit unions were offering an average interest rate of 3.22% for a 48-month used car loan. Banks, on the other hand, were offering an average of 5.24% for the same loan.

Get preapproved for a loan

Once you land on a lender with terms you’re comfortable with, another good step is to get preapproved for the loan. This just means that the lender has given you a quote for the loan, which typically includes the loan amount up to a certain dollar amount. But remember a preapproval is not a guarantee. Note that when you get a preapproval letter, the lender will usually check your credit, which can result in a hard inquiry.

If you’re preapproved for a loan, the lender will typically give you a preapproval letter to take with you when you go car shopping. Then when you settle on a car, you may be able to use that preapproval as a bargaining chip. Ask the dealer: “Can you beat this financing?” If it can’t, then at least you know you’ve got another loan to consider.

If getting preapproved for a loan makes you leery, know this: Car loan preapproval doesn’t actually mean you’ve signed up for the loan. You can choose to apply for the car loan or not — it’s your choice.

Similarly, you don’t have to take out a loan for the full amount your preapproved for. If you find a car you’re happy with for a lower price, then by all means you can apply for a smaller loan.

Should I consider a personal loan to buy a car?

Why all this bother with car loans anyway? Why not just apply for a personal loan instead?

As it turns out, there’s a very good reason: the interest rate. Because car loans are typically secured by an asset (usually the car, which the lender can typically repossess to recoup costs if you default on the loan), lenders may offer lower rates than they do on unsecured loans, including unsecured personal loans.

How much lower? As of May 2018, the average 24-month personal loan from a commercial bank carried an interest rate of 10.31%, according to the Federal Reserve. A 48-month new car loan from a commercial bank? The average rates for those were just 5.05% — less than half as much — but keep in mind that because the loan term is longer, you’ll be paying interest for longer.

However, if you get to the point where you’re researching your options for refinancing a high-interest auto loan, a personal loan may offer certain advantages. For example, if you’re underwater on your current high-interest auto loan, you may not be able to refinance to cover the amount you owe. In that case, you might be able to qualify for a personal loan that can help you to pay off your auto loan.


Bottom line

If all of this seems like a hassle compared to walking into one of those “buy-here-pay-here” car lots, we’ll admit — it just might be. Determining your budget, checking your credit, and running through all the minutiae to shop around before you apply for a car loan isn’t exactly quick or easy.

But, here’s why you should do it: You might save money in the long run. Don’t believe us?

Let’s say you take out a $20,000 car loan for 48 months. If you settle for a high interest rate — say, 9% — you’d end up paying around $3,890 in interest charges before paying off the loan.

But what if you do the work to find a better interest rate (say, 5%?) Then you’d only owe around $2,108 in interest — $1,782 less, and the savings may only cost a few hours of your time.


About the author: Lindsay VanSomeren is a freelance writer living in Kirkland, Washington. She has been a professional dogsled racer, a wildlife researcher, and a participant in the National Spelling Bee.… Read more.