I bought my first car from my parents. It had lots of miles and no frills — not even air conditioning — but the price was right and they sold it to me cheaply enough that I could pay cash. My second car, though, was a gray Mustang convertible I found in the classifieds (no Craigslist back then). For that one, I had to get a car loan, so I turned to my local bank. I didn’t really have a clue what I was doing, but they walked me through the process.
If you are thinking about getting your first vehicle loan, you may feel a bit overwhelmed as well. Here’s how the process of getting a car loan works.
Step One: Check Your Credit
Your credit score will play a key role in the rate you’ll pay for your loan. While that may sound obvious to someone who has applied for one of these loans before, if you are a first-time car buyer, you may not realize how important your credit score is when it comes to getting a loan. A high credit score can help you get a low car loan rate, which in turn saves you money on interest.
Your credit score is based on the information in your credit reports, so to make sure that your credit score is accurate it’s a good idea to also get your credit reports. You can check them for free once a year.
It’s also a good idea to get your free credit score to see where you stand (and you can do that using Credit.com’s Credit Report Card). Just understand that you probably won’t see the same credit score the auto lender will see. There are many different credit scores available, and auto lenders typically use scores customized for auto lenders.
Step Two: Pick Your Payment
Your job here is to figure out how much you can realistically afford to spend each month on a car payment without straining your budget. Once you know that amount, you can plug it into a car loan calculator to find out the total you can afford to spend.
Car loans typically come in 3-, 4-, 5- and 6-year terms. The longer the term of the loan, the lower the monthly payment. But a longer car loan also means you are likely to be “upside down” for a longer period of time. To be upside down (or “underwater”) on a loan means you owe more than the vehicle is worth.
Don’t forget to factor in insurance and maintenance costs. While those won’t be included in your monthly payment, you’ll have to come up with those funds as well. If you have trouble paying them, you may find it hard to keep up with your car payment, so you want to make sure you are prepared for the total cost. An insurance agent can help you estimate the cost of insuring the types of vehicles you are considering buying.
Step Three: Get Pre-Approved
You can shop for an auto loan online, as well as through a local credit union or bank. You don’t have to limit yourself to the financial institution where you do your banking, and it’s fine to check with a few different sources. You want to see what kind of loan, and for what amount, they can offer. Whichever one offers you the best deal, that’s the one you can get financing through.
If you qualify for a loan, you’ll get a “pre-approval” that will be good for a certain period of time and up to a certain amount of money. It’s sort of like having a blank check to buy your vehicle. You can always spend less than the amount for which you are pre-approved, but you can’t spend more, unless you want to make up the difference in cash or by trading in your current vehicle. If you do buy a vehicle for less than the amount for which you have been pre-approved you won’t get the difference back in cash; you’ll just get a smaller loan.
Don’t have great credit? You may still be able to get pre-approved for a car loan with bad credit, but your interest rate will be higher. If you have no credit history, you can either ask someone to co-sign or consider a lender that will work with borrowers with no credit.
Try to do all your car loan shopping within a 14-day period. That’s because some credit scoring models will penalize you if there are too many inquiries into your credit history. But none of them will do so if those inquiries are within a two-week window.
Step Four: Choose Your Vehicle
Once you are pre-approved, you can get serious about shopping for your vehicle. One of the good things about being pre-approved is that you can focus your efforts on negotiating the best deal for the car or truck you want to buy, rather than having to negotiate financing as well.
If the dealer can beat the terms you’ve been offered for a loan, you may want to take it. Just be careful: the dealer may try to talk you into a longer loan that will reduce your monthly payment, but will cost you more in the long run.
If you are going to buy a used car from a private party, make sure the loan you apply for covers that option. Also make sure you understand the restrictions on used car loans. You may not be able to buy a vehicle older than five years or with more than 75,000 miles, for example. And keep in mind the interest rate for these vehicle loans may be a little higher.
Step Five: Finalize the Paperwork
Once you’ve chosen your vehicle and negotiated the price, the auto dealer’s financing department will coordinate with the lender to finalize the sale. They will very likely try to get you to buy add-ons, such as an extended warranty, VIN etching, paint or fabric protection etc. Be sure to research these ahead of time so you don’t feel pressured into making an uninformed decision.
If you buy a used car from a private party, your lender should walk you through the process of finalizing the sale.
Step Six: Start Paying Your Car Loan
After the sale is finalized, you will get information about the payment schedule for your loan. Most lenders will send a coupon book you can use for mailing in your payments, along with information on how to access your account online. Even if you plan to pay your loan by mail or at a local branch of your financial institution, it’s a good idea to sign up for the online service so you can check your balance and payments if you need to, and so you’ll be able to make payments online if you are traveling, for example.
Almost every car loan allows you to prepay without a penalty, so if you decide to pay off your loan faster you can do that. Just be sure to check with your lender to make sure your additional payments are processed correctly.