How to Apply for an Auto Loan

Purchasing a new or used car is an exciting experience, whether it's your first car or you're upgrading to your dream car. Part of the car buying process involves deciding how you'll pay for the vehicle. Because cars are a major expense, most car buyers finance some or all of the vehicle’s cost with an auto loan.

Getting an auto loan is a relatively straightforward process, but if you’ve never taken out a car loan, it’s important to understand how it works and what to expect. In this guide, we’ll explain how to apply for an auto loan, step-by-step.

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What Is an Auto Loan?

An auto loan is one method of financing a car purchase. You borrow money from a lender, like a bank or credit union, which is used to buy a used or new car. In exchange for the money, you agree to pay the full amount back, plus interest, over a specific time frame (usually between 24 and 72 months).

Until the auto loan is paid off in full, your lender legally owns the vehicle. If you stop making the payments, the lender has the authority to repossess your vehicle as collateral. Once the loan is paid, you become the legal owner and can sell or trade in the car whenever you want.

Determining Your Budget

Before you start shopping for a new or used car, it's a good idea to figure out how much car you can afford.

Most financial experts recommend spending no more than 10 percent of your take-home pay on a monthly auto loan payment. You can also use an auto loan calculator to figure out how much you can afford to spend on a car.

Once you’ve determined your price range, you should research what taxes and fees you’ll need to pay as part of the transaction. Taxes and fees depend on the state where you're buying the car, whether it's new or used, and whether you're trading in a vehicle as part of the transaction.

How to Apply for a Loan

Applying for a car loan isn’t complicated, but there are a few things you can do to simplify the process. Here are the steps you should follow if you want to take out an auto loan:

1. Compare Lenders

Before you submit a loan application, take some time to compare different lenders. You might start with your bank or credit union, as an established relationship can help you qualify for a better rate.

It's also smart to look at online lenders and financial institutions, as they might charge fewer fees due to lower overhead costs. A dealership can also provide financing for cars purchased at their location.

When comparing lenders, make sure you're looking at similar loans. For example, start by comparing terms for a $15,000 loan over 60 months. See what interest rates different lenders charge, and what discounts are available.

It's also important to assess potential loans for any hidden fees, add-ons, and other extra costs. These can cause your monthly payment to increase substantially and could make it harder to afford the car you want.

You should also see if the lender assesses a penalty for early payment. This isn’t ideal, because it limits your ability to pay off the loan early, which can help you avoid high interest fees.

2. Check Your Credit

Your credit history and credit score affect your ability to qualify for a car loan, as well as the interest rate you receive. Some auto lenders offer financing to borrowers with lower credit scores, but these loans usually come with higher interest rates and less favorable terms.

Before you start applying for loans, check your credit so you know what to expect. A good credit score is usually 661 or higher. You typically need a score of at least 500 to qualify for a car loan at all.

If your score falls below the minimum requirement, you'll probably have to work with a lender offering subprime loans or a loan program for car buyers with poor credit.

3. Improve Your Credit Score

If your credit is low, consider taking steps to improve your score before applying for a car loan. Paying down your debt, going through the debt consolidation process, and making on-time payments can all help you improve your score. Decreasing your credit utilization amount can also boost your credit score.

4. Determine Your Down Payment

When you buy a car, you typically have to pay a portion of the total cost in cash. This is called the down payment. Some lenders have strict down payment requirements, such as a percentage of the purchase price. Others allow buyers to choose their own down payment amounts.