Purchasing a new car or used vehicle is a significant financial decision, and there are some important steps you should take before applying for a car loan.

Having a budget in mind, knowing your credit score and comparing your loan options will guide you to the best fit for your finances. And by being prepared, you can save time and money — and potentially negotiate a better price when you’re ready to buy your car.

Key takeaways

  • Applying for preapproval can help you know how much you can afford and negotiate at the dealership.
  • The higher your credit score is, the lower your interest rates may be. Lenders offer competitive terms to borrowers with good to excellent credit.
  • Have a budget in mind and know your credit score so you can find the best lender for your finances.

What to do before you apply for an auto loan

Before visiting a dealership or looking 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.

Keep in mind that vehicle upkeep is more than just the monthly loan payment. It includes 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.

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Shop the total amount, not just the monthly cost. Focus on the entire cost you will pay throughout the loan and the incidental expenses of owning a car, like maintenance, car insurance and gas.

2. Clean up your credit report

Your credit score will almost always be the primary factor for your interest rate, which will influence your out-of-pocket monthly cost and the overall cost of the loan.

Lenders tend to offer better rates to borrowers with scores above 670. Applicants with scores above 740 may be able to qualify for 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 credit utilization ratio. By paying off bills and keeping your credit card use low, you may be able to boost your score quickly, and that may help you score a competitive rate.

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If your score is lacking, start your search with bad credit auto loans. They tend to have more lenient requirements. Your debt-to-income ratio may also matter, but lenders will primarily want to see that you can handle your debts.

3. Gather your documents

When you submit a loan application, be prepared to provide documents on your personal and financial information.

  • Personal information: Your name, date of birth, address, driver’s license and Social Security number.
  • Proof of address: Bank statement, utility bill, lease agreement or mortgage statement.
  • Proof of income: Pay stubs, bank statements or tax returns.
  • Vehicle information: Age, make, model, trim, current mileage and vehicle identification number (VIN).

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.

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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 for loans at banks, credit unions and online lenders, along with dealership financing, is key to getting the best auto loan rates and terms.

Even if the interest rate with one lender is only one or two percentage points lower than the others, you could save hundreds over the loan term and have a lower monthly payment.

For example, you would save over $1,500 in interest on a $36,000 auto loan with a four-year term.

Interest rate Monthly payment Total interest paid
5% $829 $3,795
7% $862 $5,379

You should also read the fine print and check on extra costs, such as fees or penalties. Ask about the eligibility criteria and loan terms the lender offers. There is no single best loan for everyone, so search for a lender 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. Look out for a “conditional approval” clause that can result in higher rates than you initially signed for as well as other predatory sales tactics to avoid.

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Shop around and calculate the cost of your loan — both the monthly payment and total interest you will pay. This can help you pick a loan that fits your budget, negotiate at the dealership and find the best rates.

5. Apply for loan preapproval

Applying for loan preapproval is one of the best ways to put yourself in control when negotiating with a dealer. 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.

Multiple preapproval quotes can help you land the best rate — we recommend getting at least three. 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 temporary drop to your credit score.

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Many lenders also offer a prequalification process with only a soft credit check. Prequalification is not an official offer and won’t put you in a strong negotiating position at the dealership, but is a useful tool for comparing possible rates among multiple lenders.

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.