What Do You Need To Finance a Car?

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With new car prices averaging over $48,000 and used cars averaging over $25,000, according to Kelley Blue Book data, most people need to finance their auto purchase. But, what do you need to finance a car?

From the credit requirements to the documents you need to bring, knowing the process helps avid missteps and get approved quickly.

Keep reading to find out what you need to do to finance a car.

How Does Car Financing Work?

Financing a car means borrowing money from a lender to pay for it. You’ll then repay the loan, with interest, in monthly installments.

Where Can You Get a Car Loan?

You can get car loans from several different types of lenders:

Dealer-Arranged Financing

Car dealers can arrange financing for you through third-party lenders. This is a convenient way to borrow, but dealers mark up the rates charged by their lending partners, so you might pay more than you’d get from financing elsewhere.

Bank or Credit Union

You can apply for a car loan through any bank or credit union that offers the loans. Rates are often competitive, but you’ll need to prequalify to use the loan to negotiate a better deal with the car dealer. Some banks and credit unions will approve your loan in advance if you buy through one of their approved dealers.

Online Lenders

Online car loan companies offer some of the quickest approvals and most competitive rates.

Dealership Financing

Some dealerships offer direct “buy here, pay here” loans for buyers with subprime credit who don’t qualify for traditional financing. The rates are high and loan terms might be limited, so consider a “buy here, pay here” loan to be a last resort.

It’s important to note that car loans are secured by the car itself, so the car can be repossessed if you default on the loan.

What Do You Need To Get Approved for a Car Loan?

Even though the car you buy will serve as collateral for the loan, car loans are risky for lenders. Part of the reason is that cars quickly depreciate, with a new car losing 30% of its value in the first two years and 8% to 12% per year after that, according to Kelley Blue Book. That could leave you owing more than the car is worth. So, to offset that risk, car lenders set standards you’ll need to meet to qualify for financing.

1. A good credit score: In addition to helping you qualify for the loan, a good credit score can earn you a lower interest rate.
2. Proof of income: You’ll need your most recent pay stubs, bank statements, or both, showing your paycheck deposits. If you’re self-employed, you’ll need bank statements showing your payment deposits and possibly a tax return.
3. Employment verification: Some lenders require proof of steady employment. Have W-2 forms — or two or more years’ worth of tax returns if you’re self-employed — ready just in case.
4. Personal identification: This should be a government-issued ID such as a driver’s license or passport.
5. Proof of residence: A utility bill in your name, showing the address listed on your other documents. This serves as proof of residence.

If you’re trading a car in, you’ll also need the title. In addition, you’ll need insurance and might need specific coverages to satisfy your lender’s requirements.

Credit Score Requirements for Car Financing

Your credit score is the primary factor lenders consider when deciding whether to approve your loan application. Although you can get a loan with a low credit score, the lower your score, the more challenges you’ll face in financing a car.

Here’s a breakdown of FICO Auto Scores and what you can expect in terms of auto financing for each category of credit.

• Excellent credit (780 and above): Super prime credit. You may qualify for the lowest interest rates
• Good credit (661 to 780): Prime credit. You may qualify for competitive rates and a good selection of loan terms.
• Fair credit (601 to 660): Non-prime credit. You might qualify for traditional financing, but at higher rates.
• Poor credit (501 to 600): Subprime credit. You might need a larger down payment and a cosigner to avoid a subprime loan.
• Very poor credit (500 or less): Deep subprime credit. You might qualify for buy here, pay here financing with sufficient income and employment history.

How Much Do You Need for a Down Payment?

Many lenders recommend a down payment of at least 10% of the purchase price for a used car and at least 20% of the purchase price for a new vehicle. This is a good guideline for a few reasons:

• It reduces the risk that depreciation will leave you “underwater” on your loan, i.e., owing more than the car is worth.
• It reduces the amount you need to borrow, which helps keep the payments affordable and results in less interest paid over the life of the loan.
• Having your own cash invested makes you a less risky borrower and could get you a lower interest rate.

Some dealers allow you to purchase with 0% down. That seems like a good deal at first glance. However, 0%-down loans are riskier for lenders, so they usually come with higher interest rates.

Loan Pre-Qualification vs. Pre-Approval vs. Loan Application: What’s the Difference?

It’s a good idea to hold off on applying for a car loan until you’ve found the car you want to purchase. Budgeting is easier, though, and you might have more negotiating power if you find out how much you qualify to borrow and how much you’ll pay for a loan before you start shopping.

Prequalification

The first way to do that is with a prequalification, which provides you with an estimated credit limit and interest rate based on self-reported credit and income information. Prequalifications are useful for comparing rates from multiple lenders.

Preapproval

The second way to do it is by getting a preapproval. This gets the ball rolling on your loan application and provides you with a rate quote and credit limit based on verified credit information. It’s a more reliable indicator of your ability to get financing, and it gives you a more accurate rate quote and credit limit. In some cases, the preapproval application is the loan application, but the preapproval process is preliminary, and approval is conditional.

Some lenders use the terms prequalification and preapproval interchangeably. Make sure what your lender provides is based on verified information if you want to use it to negotiate your sale and get a more accurate picture of how much you can spend and the rate you’re likely to pay.

Loan Application

The loan application is a formal version of the preapproval. If you haven’t already submitted your income and employment verification documents, you’ll include them with your application. The lender will verify any new information and re-verify information already submitted before issuing its final approval.

Here’s a summary of the differences between a prequalification, pre-approval and a loan application:

Step-by-Step Guide To Financing a Car

Here are the steps you’ll follow to finance your new or used car.

1. Check your credit score: It’s a good idea to know where you stand before you apply for a loan.
2. Set a budget: Factor in loan payments, including interest, as well as dealer fees, taxes, registration and insurance.
3. Compare lenders: Get quotes from several different lenders, including banks, credit unions and online car loan companies.
4. Get pre-approved: Heading to the car dealership with a preapproval in hand gives you leverage you can use to negotiate a better price or other perks.
5. Choose your car: Find the right vehicle for your budget and transportation needs.
6. Apply for the loan: Submit any required documents and wait for your final loan approval.
7. Review loan details: Double-check the interest rate, loan term and monthly payment, as well as the lender’s prepayment policy and insurance requirements.
8. Sign the agreement: If the loan is accepted, sign the agreement to finalize the deal and drive off in your new car!

Pros and Cons of Financing a Car

Car financing has pros and cons you should consider.

Pros

• Makes buying a car more affordable by spreading payments out over several years
• Builds credit if you pay on time each month
• Flexible loan terms let you customize your repayment period to fit your budget

Cons

• Interest adds to the cost of the car
• Missing payments can hurt your credit score
• Long terms can lead to owing more than the car’s value.
• Might be required to purchase from a dealer vs. a private seller.

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