Most consumers wait until they’ve chosen a vehicle before looking at how to finance their purchase, but you can save a tremendous amount of money by shopping for the right auto loan and getting a preapproved financing deal before you head for the dealership. Not having a car loan in place before shopping can be one of the most expensive car-buying mistakes you can make.
In this article, we’ll look at the reasons why it’s a good idea to have financing in place before you buy a used or new car, how to find a car loan, and how to use your preapproved offer in the buying process.
- What Is a Preapproved Auto Loan?
- Preapproved vs. Prequalified: What’s the Difference?
- Reasons Why Being Preapproved Is a Great Idea
- Reasons Why You Might Choose Dealer-Arranged Financing
- Preapproval and Bad Credit
- Where Do I Find Preapproved Car Loans?
- How Do I Get a Preapproved Auto Loan?
A preapproved auto loan is precisely what it sounds like. It’s a car loan that has been conditionally approved by a financial institution before you even go to a car dealership to pick out a new vehicle. It’s “conditionally” approved because the lender will need information about the vehicle you are buying and the exact amount you are borrowing before they can complete the car loan paperwork.
Though most preapprovals will only have an approximate number for the amount you are borrowing, they generally can give you an idea of your monthly payment. If you don’t borrow the entire amount, your payments will be lower.
In order to get a preapproved auto loan, you will have had to go through a loan application and approval process. We’ll discuss the loan process a bit later in this article. In today's connected world, you can easily get preapproved financing and set up automatic payments without ever leaving your house, though some lenders will need you to swing by a branch to sign the loan paperwork.
Preapprovals and Lease Buyouts
Getting an auto loan preapproval is essential if you plan to purchase a vehicle you are currently leasing. By having a loan offer in place, you'll be able to get the best loan terms possible when you return to the dealership with your lease and start the purchase paperwork. The dealer may be able to beat your preapproved offer, but if you don't have one, they'll have no incentive to do so.
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There's a vast difference between being preapproved for an auto loan and being prequalified. To be preapproved, you will have to fill out a loan application, have your credit checked, and meet the lender's criteria for borrowing the amount of money you are seeking. With a preapproval, you'll know the interest rate on the loan and the length of time you'll have to pay back the financing.
A prequalification, on the other hand, doesn’t require you to fill out a loan application. It may give you an idea of how much you can borrow, how long you can borrow it, and the interest rate. A prequalification does not bind you or the lender to any terms offered.
As often as not, a prequalification is a marketing tool used by lenders or car dealers to jump-start interest in buying or borrowing – even if you are not actively looking to purchase a car. Prequalifications are based on what is called a “soft-pull” of your credit report, which does not affect your credit score like a “hard-pull” credit report triggered by a loan application would.
When it comes to car buying, a loan prequalification really doesn’t mean much. It’s like the prequalified credit card applications you get in the mail. An auto loan preapproval, however, is a great tool to have when you walk into a dealership.
Having your car loan preapproved from a bank, credit union, or other lender can save you money, time, and hassle. Here are several reasons why:
Helps You Set Your Budget
Shopping for an auto loan can help you narrow your car-buying choices by assisting you in setting a reasonable new or used car-buying budget. To understand why, it's essential to know the difference in a lender’s goals compared to a car dealership’s objectives. A dealership’s goal is to generate the highest profit possible, and there’s nothing wrong with that as long as they act ethically and legally during the process. That goal, however, can lead more unscrupulous dealers to sell you a more expensive car than you can realistically afford or offering you a financing package that makes them the most money, rather than providing you with the best deal.
A lender’s goal, on the other hand, is to make you a loan that they have confidence you can successfully pay back on time. That means one with monthly payments that fit your monthly budget and a loan length that’s not so excessive it causes them undue risk. Of course, they'll want to make as much money off the loan as they can, but the financial institution will also realize they have to earn your business with attractive loan terms.
Because the lender’s goal is to make a loan you won’t default on, their approach is more likely to be based on a reasonable loan amount and financing terms. When you know how much a lender is willing to loan, you’ll be able to set an appropriate, affordable car-buying budget.
Simplifies the Buying Process
Step into any car dealership, and one of the first questions a salesperson will likely ask is "how much do you want to pay per month." Knowing how much you can afford each month allows them to craft a deal that maximizes how much they can charge for both the car and the financing. A good salesperson and sales manager can shuffle the numbers to make it look like they’re giving you a great deal when they might not be. If you have a trade-in or down payment, the transaction can get even more confusing. Have no doubt, confusion is your worst enemy and their most powerful tool.
As a buyer, you want to negotiate based on the price of the car and the cost of the financing. While the monthly payment needs to fit your budget, it's far from the most crucial number involved in your new or used car purchase. By going into the dealer with a preapproved financing deal, you can take the auto loan element of the salesperson’s shell game off the table, simplifying the buying process for you.
Powerful Negotiation Tool
Having a preapproved auto loan in hand when you walk into the showroom makes negotiating easier. Instead of having to go back and forth with financing offers, you can simply use the offer you have in hand as the benchmark they have to meet or beat if they want your business. In many ways, having the loan offer in hand gives you the power of an all-cash buyer.
Often a Better Deal
Because an outside financial institution is competing with others to make you a loan, they'll frequently give you a better deal than you'll get at a dealership whose primary goal is to sell you a car. Lenders often have loan specials. With some research, you can find and take advantage of those offers.
Car dealers frequently counter this argument by saying they have access to hundreds of lenders. That’s true, but you as a buyer do too. Online lending sites can also help you find the best financing deals in the marketplace from an array of hundreds of lenders.
You Don’t Pay a Markup
While dealerships make some of their money by selling cars, it’s not the only profit-generating thing they do. They also make money servicing cars, selling add-on products, and marking up the financing offers on new and used car sales.
Here’s how it works: Car buyers give the dealer the information they need to find financing deals for their buyers. When the dealers get offers from lenders, they mark up the interest rates or fees the lender offered and take the difference as profit. It's a perfectly legal and acceptable practice, and in most states they are not required to tell you that the rate or fees have been marked up (or by how much).
By bringing an attractive financing deal of your own to the transaction, you limit their ability to mark up the offers they get. It also limits their ability to promote offers that are better for their bottom line than they are for your wallet.
You Avoid Yo-Yo Financing
While most car dealers act professionally and work with buyers to give them a fair deal for both sides, theirs one business practice that still happens, and is horrible for consumers. It’s called yo-yo financing or the spot financing scam. Instead of finalizing the loan before you leave the dealership, they let you drive the car home with a conditional approval and the impression that they just need to file the paperwork with the lender.
However, buyers get a call several days after leaving the dealership in their new ride with a message that their financing fell through, and they need to return to the dealer to sign new paperwork. When they do, they find a deal that's much more expensive than the numbers they initially agreed to. Because they've been driving the car and the dealer is often applying lots of pressure (and occasionally making threats), they sign the new paperwork. In some cases, the financing legitimately fell through, while in others, the sales manager knows that you would never qualify for the original offer.
The best course of action if this happens is to immediately contact other lenders and see what kind of deal you can get. If you can't get an affordable deal, return the car and unwind the original agreement. Then walk away from that dealership as quickly as you can. In some states, consumers are well protected against the yo-yo scam, while in others the law is on the side of the dealership.
When you have your own preapproved financing in place before you start shopping, you’re less likely to fall prey to the yo-yo financing scam.
Many buyers just use financing arranged by the dealership. It can be quicker and more convenient than getting an outside auto finance deal, though that convenience often comes at a price. Most dealerships have relationships with many lenders, and their systems can make the paperwork easy.
If you're seeking a special financing deal from an automaker, you'll have to let the dealership handle the paperwork. Only franchised new car dealers from the brand offering a special financing or cash back deal can provide the incentives to customers. Taking advantage of an interest rate that’s significantly below the average market rate can save you thousands of dollars over the life of the car loan.
Even if you are planning to take advantage of a special car deal, it’s a good idea to have a preapproved offer from an outside lender in hand. Car deals come loaded with fine print, and it’s good to have a backup plan in case the special financing deal isn’t available when you need it or on the vehicle you choose.
You can find the best financing and cash back deals offered each month on our new car deals page.
If your credit is less than perfect, it's even more vital for you to get a preapproved car loan before you start shopping. Buyers with credit challenges can easily find themselves with loans that are not right for their circumstances, they can’t afford in the long run, or they pay way too much for if they don’t shop for financing well before they start shopping for vehicles.
Ideally, car shoppers should look at their credit score well before they start shopping, so they know what kind of deal to expect. Far too often, car buyers discover how bad their credit is when they're sitting in the dealer's financing office trying desperately to get an auto loan for that dream car that’s sitting mere feet away.
Many credit card companies offer a peek at your credit score as a benefit of carrying their card. There are also many websites, such as CreditKarma that provide your score in exchange for some personal information. Avoid sites that tie getting your score to signing up for expensive credit monitoring services, as there are plenty of places to see your score for free.
If your credit ratings aren’t as high as you think they should be, you’ll want to look at the full credit reports that they’re drawn on to see where the issues are. You’re entitled to one free credit report per year from each of the three major credit reporting agencies – Experian, Equifax, and TransUnion. The only official place to get your reports for free with no strings attached is AnnualCreditReport.com. Correcting incorrect information and taking steps to improve weak areas on your credit reports takes time, and that's why you need to look at your reports well before your vehicle buying journey begins.
Unfortunately, some unscrupulous car dealers prey on customers with bad credit by putting them into finance deals that they simply can’t afford in the long run. Some outside lenders, including community banks and credit unions, have programs to work with borrowers with credit challenges. Since lenders have the most to lose if they make bad loans, they’re likely to be brutally honest with you about how much you can realistically afford.
Just as there are many dealerships where you can buy a car, there are many places to get a preapproved auto loan at competitive rates. Before deciding on where to finance your preowned or new car, you should shop several lenders to find the best deal. Fortunately, you can do most of your comparison shopping online.
Large national banks have streamlined processes to make borrowing easy and lots of branches if you need to talk to someone in person. Their rates tend to be a bit higher than some other lenders, however. Smaller regional and community banks typically are easier to work with than their larger siblings if you have special situations that one-size-fits-all financing doesn’t work for or need a bit more attention during the application and approval process.
Credit unions are member-owned cooperatives that frequently have lower rates than banks because they don’t have shareholders and turn their profits back to members through lower loan interest rates and higher savings annual percentage rates. Credit unions range from tiny operations that serve one company to huge enterprises that rival the size of national banks. To borrow from a credit union you must become a member. Not everyone can join some credit unions.
Auto finance companies differ from other financial institutions in that their only business is lending money. They don’t offer savings accounts or credit cards, for example. Often they serve specific types of borrowers, such as those with subprime credit scores.
Before you start entering any personal information into a site you’re not familiar with, it is a good idea to check with local consumer watchdogs, such as the Better Business Bureau, to see if there are any significant complaints.
To get a preapproved loan offer, you will have to fill out a loan application and be approved by the lender. Since you don’t know the specific car you’ll be purchasing using the car loan, it’s a good idea to get preapproved for an amount on the higher end of what you expect to pay. Our car affordability calculator can help you determine how expensive of a car you should be considering. If you already have a vehicle in mind, our auto loan calculator will show you the monthly payments you’ll likely have.
Applying for a Loan
The first step in a preapproval is filling out a credit application. You’ll be asked for a host of personal information, from your employment status to your social security number. If you are self-employed, you can expect to be asked for information proving your income, such as multiple years’ worth of tax returns. Any co-signer on the loan will also have to fill out an auto loan application and provide their personal information.
Don’t be tempted to fudge the numbers on the application, leave out important information, or outright lie. If a lender catches your omissions or dishonesty your loan will likely be denied. If they approve your loan and later discover the issues, they can demand immediate repayment of the entire loan balance.
What the loan application does is allow the lender to create a picture of your finances and ability to repay the loan.
Credit Scores and Reports
The other factor almost all auto lenders consider is your credit score. You actually have several credit scores, with different credit reporting companies using slightly different models to assess your creditworthiness, but they’re all usually pretty close to one another. A credit score is a three-digit number ranging from 300 to 850. Scores at the low end of that range denote bad credit and tell lenders that you may not make your car payments, while those at the high end signify that you have excellent credit and are more likely to pay back the loan as agreed.
The most significant factors used in determining your credit score include your track record of paying your bills on time, the amount of debt you have, and the amount of debt you have access to (your credit limits).
Using the information from your loan application and your credit score, the lender will decide whether or not to extend an auto loan to you. They will look at how much you earn and how much you owe to create a debt-to-income ratio. Different lenders have varying criteria of what an acceptable balance is.
If you are approved for the amount you requested, ask the lender to give you the approval in writing so you can take it along when you're shopping. They'll still have a lot of paperwork for you once you pick out a car, so be sure to let them know the vehicle you choose and its vehicle identification number (VIN) as soon as you know it.
A lender may also come back with certain conditions, such as a maximum loan length, a requirement for a minimum down payment, or a minimum loan-to-value ratio (LTV). An LTV is the ratio of the loan balance to the value of the car. LTVs greater than 100 percent are much riskier to lenders than those below 100 percent. It’s common for lenders to place higher interest rates and other restrictions on used car loans than they do on new car loans.
Sometimes a lender will decline to lend you money because they don’t feel you have the ability to repay the loan. If you are declined, a lender is required to tell you why, and you’re entitled to a copy of any credit reports they used to support their decision. Getting turned down for a loan can be a blessing in disguise, as it means that a lending professional thinks you won’t be able to make your car loan payments. You should look at the reason you were declined and address that issue before you apply for another loan.
Read our article on financing a car and getting an auto loan to learn more about this subject.
More Shopping Tools From U.S. News & World Report
Finding auto financing before you start car shopping is like eating your vegetables before you dive into the main course. When it’s time to find the right car, U.S. News & World Report offers a vast buffet of resources to find a ride that fits your needs and budget.
Our new car rankings and reviews use the consensus opinion of the country’s top auto journalists, combined with quantitative data on safety and predicted reliability, to rank nearly every new vehicle you can buy today. Our used car rankings and reviews add data on cost of ownership into the ranking equation to ensure you can find a preowned vehicle that won’t cost you money in repairs and maintenance as it ages.
Even better than finding a great vehicle is finding a great deal on that vehicle. We track the best money-saving financing and cash back offers from manufacturers. You can find them on our new car deals and used car deals pages. You can save even more money by using our Best Price Program. We work with local dealers to provide prenegotiated prices to purchase or lease customers. Buyers save an average of more than $3,000 when they use the program.
An important part of car ownership is having the right auto insurance. Our car insurance hub will help you find the coverages you need, the insurance discounts you’re entitled to, and the right insurance company.