How to Qualify for a Car Loan

Dreaming of hitting the open road in a shiny new car? Before you rev up those aspirations, let's navigate the crucial terrain of car loans. Think of this guide as your key to unlocking the doors of auto financing wisdom. From understanding interest rates and loan terms to unraveling the mysteries behind credit scores and income requirements, we're here to make sure your journey to car ownership is smooth, straightforward, and, most importantly, on budget. So, buckle up—we're about to take the guesswork out of car financing and put you in the driver's seat of your dream car.

Know Your Car Loan Vocabulary

Whether you’re a first-time car buyer or someone looking to brush up on auto loan terms, we’ll go over the jargon associated with car loans, ensuring you know the vocabulary before you go car shopping.

• Car or auto loan - A car loan is a financial product that allows individuals to purchase a vehicle by borrowing money from a lender.
• Interest - Interest is the cost of borrowing money, expressed as a percentage of the loan amount. It's crucial to understand the interest rates associated with car loans.
• Principal - The principal is the initial amount borrowed, excluding interest. Repayments made on the loan contribute to reducing the principal amount.
• Loan term - The loan term refers to the duration of the loan agreement. It's essential to consider the length of the term when choosing a car loan.
• Vehicle title - The vehicle title is a legal document that proves ownership of the car. It is held by the lender until the loan is fully repaid.
• Loan to value ratio - It represents the percentage of the car's value that the lender is willing to finance. While it's important to keep the LTV ratio at or below 100% to prevent potential loan issues, please note that our policy allows for ratios exceeding 100%. However, we still encourage you to aim for keeping it at 100% whenever possible.

Factors that Impact Your Loan Approval

Know Your Credit Score and Why It Matters

Your credit score has a significant impact on the auto loan you can secure. Understanding this link is essential for all car buyers, whether they're purchasing a new luxury car or a reliable used vehicle. A good credit score can open doors to favorable auto loan terms, which includes a better interest rate that can save you thousands over the lifespan of the loan.

Lenders evaluate credit scores, payment history, outstanding debts, and other financial behaviors to gauge the risk associated with lending to an individual.

If you've discovered that your credit score is not in the ideal range for the best auto loan rates, it's not the end of the road. There are several steps you can take to improve your credit score and enhance your car buying experience:

• Pay down existing debt – Reducing your credit card balance or paying down high balances.
• Correct credit report errors – Regularly check your credit report for errors and disputing any discrepancies.
• Avoid opening new credit accounts – Each time you apply for a new credit amount, a hard inquiry is placed on your credit report, which can temporarily lower your score. Avoid opening any new accounts in the months leading up to your auto loan application.
• Make all payments on time – Paying all bills and loans on time will ensure a significant, positive impact on your credit score.
• Consider a secured personal loan – if you have a thin credit profile or are rebuilding from a credit stumble like bankruptcy or foreclosure, a secure personal loan can be a helpful credit-building tool.

Income and Employment Requirements

Before a lender extends an auto loan, they need assurance that you can make the monthly payments. This assurance comes in the form of your income and employment history. Essentially, lenders look at earnings and stability to gauge your ability to shoulder the financial obligation.

If you're employed, lenders not only check that you are, but also assess the length of your employment history. Job stability signals a consistent income, a crucial factor for lenders. For some, establishing a stable job history might mean waiting to make a major purchase. However, for those who can demonstrate steady work, it goes a long way in securing a favorable auto loan. Temp jobs, freelancing, and gig economy work are rising trends, but they can pose challenges in convincing traditional lenders of financial security.

The Importance of Your Debt-to-Income Ratio

When it comes to purchasing a new vehicle, it's not just your credit score that sings the saga of your financial responsibility; it's also the lesser-known star of the show—the debt-to-income (DTI) ratio. While many car buyers focus solely on getting their credit score in tip-top shape for the big purchase, understanding and managing your DTI ratio is equally crucial.

For auto loans, DTI considers your existing monthly debt obligations, including student loans, credit card payments, and any other loans, as well as the estimated monthly payment of the car loan you're seeking. A high DTI ratio can signal that you may be overextended financially and could be a higher risk for lenders.

Calculating Your DTI

The formula for DTI is simple:

DTI = (Total Monthly Debt Payments / Gross Monthly Income) x 100

Start by adding up all your monthly debt payments and divide the total by your gross monthly income (what you earn before taxes and deductions). Multiply this figure by 100 to get your DTI percentage.

Down Payment & Trade-In

A down payment is an upfront payment made at the time of purchase. It reduces the loan amount and lowers monthly payments. Unlike the loan amount, the down payment doesn't accrue interest. The higher your down payment, the more money you can save in interest over the life of the loan. Trading in your current vehicle can serve as partial or the entire down payment.

It's possible to secure a car loan without an upfront down payment, but it may mean financing a larger portion of the vehicle's cost.

Researching Auto Loan Lenders

Traditional Banks

Banks often cater to creditworthy borrowers and offer competitive interest rates on auto loans as part of their personal finance portfolios. They also may have more stringent credit requirements that lead to fewer approvals for those with less-than-perfect credit.

Credit Unions

Credit unions operate with a member-first ethos, often providing a more personalized customer service experience, while offering most of the benefits offered by a traditional or online lender. Due to their non-profit status, credit unions tout lower fees and more favorable loan terms.

Online Lenders

For the tech-savvy buyer who is looking for a quick and painless application process with competitive rates, there are online lenders who forego the face-to-face service for efficiency. They often provide instant or same-day approvals, expediting the car-buying process.

Comparing Auto Loan Lenders

Interest Rates

One of the most powerful financial tools at your disposal is the ability to negotiate the Annual Percentage Rate (APR) on your auto loan. Arm yourself with market research on current interest rates, pre-approved offers from other lenders, and a solid understanding of your financial position to negotiate effectively.

Additionally, consider making a larger down payment to reduce the principal amount, which can potentially influence a lender to offer you a lower APR.

Evaluate Loan Terms

Auto loan terms can be as diverse as the cars they finance. Loan durations, known as the term, range from 36 to 72 months, or even longer. Shorter terms may yield higher monthly payments but result in lower overall interest. Longer terms, conversely, incur less strain on monthly finances with a higher cumulative interest, but potentially higher overall expenditure.

Conditions and Additional Fees

An upfront low rate can hide a multitude of additional costs. Application fees, origination fees, and prepayment penalties can sour the sweetest loan deals if unaccounted for. Thorough scrutiny of the lender's fine print is obligatory to uncover any supplementary charges.

Understanding Various Car Loan Options

Fixed-Rate Auto Loans

A fixed-rate auto loan features an interest rate that does not change throughout the term of the loan. This predictability can provide a sense of financial stability, as your monthly payments remain consistent. Even if market rates soar, your interest rate—and therefore, your principal and interest payments—will not budge.

Variable-Rate Auto Loans

Unlike fixed-rate loans, a variable-rate loan features an interest rate that may fluctuate over the term. These fluctuations are generally tied to a benchmark interest rate, such as the prime rate, and can result in both higher and lower monthly payments throughout the life of the loan.

Getting Pre-approved for a Car Loan

When it comes to car shopping, getting a loan pre-approval before setting foot in the showroom can be a game-changer. It provides a clear picture of your purchasing power, allowing you to set a realistic budget and negotiate from a position of strength. With a pre-approval in hand, you can sidestep the high-pressure sales tactics by knowing exactly what you can afford and the interest rate you qualify for.

Qualifying for Pre-Approval

Lenders' requirements may vary, but the general prerequisites include:

• A stable income source
• Proof of residence
• A good credit score (typically above 660, though this varies by lender)
• A loan-to-value ratio that fits within the lender's parameters

The Application Process

The application process begins with gathering the necessary paperwork and ends with receiving your pre-approval. Streamline the steps by:

• Filling out the lender's online or in-person application thoroughly
• Being prepared to provide all the required documentation promptly

• Ensuring accuracy in your information to avoid delays or discrepancies

Upon submitting your application, a hard inquiry will be made on your credit report, impacting your score slightly. However, if you apply for multiple pre-approvals within a short timeframe (usually 14–45 days, depending on the scoring model), these inquiries should be counted as a single inquiry, minimizing the credit score impact.

Co-Signers and Guarantors

Individuals with limited credit history or lower credit scores may benefit from a co-signer's enhanced credit profile to increase approval odds. This can help secure lower interest rates by providing an additional layer of security for lenders, supporting the creditworthiness of the primary borrower.

Avoiding Common Auto Loan Pitfalls

Hidden Markups

While dealer-arranged financing might appear to be the most convenient option, it often comes with hidden costs. Dealers typically work with a network of lenders and can mark up the interest rates, known as the "dealer reserve," to increase their profit. This can result in a higher rate than you'd qualify for if you went directly to a bank or credit union.

Prepayment Penalties

A prepayment penalty is a fee that the lender imposes when you pay off the loan early. While it might not seem like a big deal at the time of signing the loan, such penalties can significantly diminish your ability to refinance in the future or pay the loan off quickly.

Origination Fees

The auto loan origination fee, commonly known as the "administrative" or "processing" fee, is a one-time charge that lenders impose for creating the loan. It typically covers the lender's cost of processing the loan application and underwriting the credit. This fee can range from a few hundred dollars to over a thousand, depending on the lender and your creditworthiness.

Not all lenders charge the same fees, and some might be more willing to negotiate than others. Buyers with strong credit profiles and are pre-approved can shave off or eliminate the origination fee altogether.

Securing An Auto Loan

Looking for a lender to obtain an auto loan? In 2023, CardRates.com recognized Community First Credit Union as the most trustworthy choice for auto loans in the state of Florida. We make the car buying and refinancing process easy while touting great, low rates, flexible terms, and no payments for the first 90 days. 

Call our express team at (904) 204-2929 or apply online today.