Purchasing a new car or used vehicle is a significant financial decision — and there are some important steps you should take before applying. You can save time and money by preparing in advance.

What to do before you apply for an auto loan

Before visiting a dealership or diving into online buying, some homework can help you get the best deal. This research will help you understand what you can afford, the price of ownership and expected loan rates based on your credit history.

1. Set your budget

Your budget is your guide to understanding how much you can afford. Use a car loan calculator to experiment with loan amounts and rates to find an affordable monthly payment. But wait until you’ve moved on to shopping for lenders to finalize any numbers.

And remember that vehicle upkeep is more than just the monthly loan payment. It includes factors such as gas, insurance, vehicle add-ons and any trips to the mechanic — expected or otherwise. Experts recommend keeping your monthly car-related expenses at or below 20 percent of your take-home pay.

Bankrate tip
Shop the total amount, not just the monthly cost. Focus on the entire cost you will have to pay throughout the loan and the incidental expenses of owning a car.


2. Clean up your credit report

Your credit score and history will almost always be the primary factor for the rates lenders offer you. These rates will influence your out-of-pocket monthly cost and the overall cost of the loan.

Credit score requirements vary by each lender. Most lenders will offer better rates to borrowers with scores above 670. Applicants with scores above 740 may benefit from the lowest rates, including 0 percent APR deals offered by the manufacturer or dealership.

But having poor credit may not prevent you from finding a lender. Many lenders are inching away from traditional acceptance criteria and focusing on additional factors like education or job history.

Either way, improving your credit before applying for a loan is in your best interest. Grab a copy of your free credit reports from AnnualCreditReport.com, highlight any areas that need improvement and dispute any errors.

Also, pay special attention to your debt-to-income ratio, which compares your monthly bills to your income. Doing so may help you score a competitive rate.

Bankrate tip

If your score is lacking, start your search with bad credit auto loans. They tend to carry more lenient requirements.


3. Gather your documents

When you submit a loan application, be prepared to provide your personal and financial information. Information on the car you want to buy is helpful, too.

  • Personal information, including your name, date of birth, address, driver’s license and Social Security number.
  • Proof of address, like a bank statement, utility bill, lease agreement or mortgage statement
  • Annual income, employer contact information and pay stubs.
  • Vehicle information, such as the age, make, model, trim, current mileage and vehicle identification number.

Vehicle information is the least important. Almost all lenders offer a preapproval process that gives you up to 30 days to shop for a vehicle. So, if you want to know how much you can afford before you hit the car lot, not having the vehicle information should not impact your approval prospects.

Bankrate tip

Having your paperwork in order also lets dealers know you’re prepared to make a purchase, which can help with negotiation.


4. Shop around

Take some time to explore your options. Shopping around for loans from traditional lenders, credit unions and online lenders, along with dealership financing, is key to knowing you are receiving the best rates and terms.

Even if the interest rate with one lender is 1 or 2 percentage points lower than the others, you could save a bundle in interest over the loan term.

Imagine you take out a four-year $36,000 loan. If you get a loan with an interest rate of 7 percent, you’ll pay $5,379 in interest over the loan term. But if you can secure a loan with a 5 percent rate, the total amount of interest you’ll pay drops to $3,795.

When considering which lender is right for you, read the fine print and check on extra costs, such as fees or penalties. Also, ask about the eligibility criteria and loan terms the lender offers. There is no single best loan for everyone, so search for a loan that fits your specific needs.

You may also be offered financing through the dealership. Most often, dealerships don’t have the best rates available. Walking in with a quote from an outside lender can give you the upper hand in negotiating a fair rate.

Bankrate tip

If you opt for dealership financing, look out for a “pending approval” clause that can result in higher rates than you agreed to.


5. Apply for loan preapproval

Applying for loan preapproval is one of the best ways to put yourself in control when it comes to negotiating. Preapprovals are usually valid for 30 days and give you a firm idea of what terms and rates you can expect with a specific lender.

The best part: You often don’t even have to have a vehicle picked out yet, only the amount and term you want. Getting multiple quotes can help you land the best rate. But keep your rate shopping to a two-week window as the FICO scoring model groups several hard inquiries into one during this period, minimizing the damage to your credit score.

Bankrate tip

While not every lender offers preapproval, the added security is a huge plus, so consider looking for lenders that offer this option.

Next steps

After setting your budget, ensuring your credit is up to par, gathering the necessary documents and shopping for the best deal on vehicle financing, the fun part can begin.

Look for the perfect ride, but stick to your budget and negotiate with the dealer before purchasing. Most importantly, shop for your car with the same thoroughness you used to get the best deal on a new auto loan.