Better Credit Blog | Credit Help For Bad Credit

If you’ve been considering buying a new car, but you’ve hesitated because you worry it will be expensive or the process of securing a loan will be too difficult, take heart. There are several steps you can take to get the best possible deal and make getting a loan, and eventually a car, a smoother process.

One of the best steps you can take for yourself is to get pre-approved for an auto loan. Just as with getting pre-approved for a home loan, getting pre-approved for a car loan will give you a closer indication of the loan rates that you might qualify for, as well as more negotiating power with car dealers. By loan rates, we mean the actual amount of interest you will owe for the loan you take out, which will vary by several factors, such as your credit history, the length of your loan, and the lender you choose, amongst other factors.

But getting pre-approved will temporarily lower your credit rating, so there are some downsides. To help you make sense of the pre-approval process and if it might be the right move for you, we talked to a number of auto loan experts to get their insight.

Do Your Research

The number one mistake people make when shopping for a car is to get financed through a car dealership without considering all of their options. “That can be a recipe to shred your wallet,” says Clark Howard, a consumer advocate and a consumer finance expert at Clark Howard Inc. “You need to shop around for the best rates before you start the car-buying process.”

Car dealerships offer financing, which is where you enter a contract to pay off your loan over a period of time, plus a finance charge. This contract is often sold to a bank, finance company, or credit union that will collect your payments.

Some companies also offer what is called “captive lender” programs, where the lending divisions of major automobile companies, such as Kia Motors Finance, will finance your purchase through a franchised dealer. But Howard says it is important to know what loans you might qualify for before you take the first offer a dealer makes you.

“It’s wise to shop several lenders during a specific time frame, so you get to see the best rates,” he says. “You should compare multiple rates, starting with your local credit union. Credit unions almost always will be the cheapest place.” In addition to credit unions, banks, online lenders, and specialty companies such as RateGenius and Autopay might offer competitive rates, so take the time to look around.

Pre-Approval Versus Pre-Qualified

When you are serious about buying a car, it is worth considering getting pre-approved for a loan, though depending on your situation, getting pre-qualified might also be a good option. As with securing a mortgage loan, both options can give you an idea of what you might qualify for and therefore your overall car-buying budget. But there are also crucial distinctions between the two.

The downside to getting pre-approved for a loan is that a lender will do a “hard inquiry” into your credit file, which will temporarily lower your credit score, usually for a few months. If you just want a general idea of the loan rates that you might qualify for and you don’t want your credit score to be affected, then Nirit Rubenstein, co-founder, and CEO of the automated credit repair service Dovly, says you might want to consider getting pre-qualified. “Pre-qualification can give you a better idea of your auto loan approval odds and potential loan terms. Getting pre-qualified can also help advance the process with a specific lender.”

Pre-qualification doesn’t give you the most precise information about your rates, just a general sense. But the upside is that “pre-qualifying for an auto loan typically will not hurt your credit score. Lenders can usually pre-qualify potential borrowers by performing a soft pull of credit-related information,” says Rubenstein. “This means that they do not make a hard inquiry on your credit during the initial application process.”

By comparison, pre-approval for an auto loan “clarifies your potential borrowing power, interest rate, and terms. It’s a more rigorous process than pre-qualification, as the potential lender requires you to submit more extensive personal and financial information and typically to consent to a hard credit pull,” says Rubenstein. “Pre-approval can then help put you in the best position to bargain with car dealerships and to shop around for a loan that best fits your budget.”

How Pre-Approval Affects Your Credit Score

The pre-approval process will give you a more precise idea of the rates you might qualify for, but it will require a hard inquiry into your credit history. This will usually temporarily lower your credit score by a few points, but the exact amount of points you will lose, and the amount of time it will take for your score to recover, will vary by lender.

Your credit score, also known as your FICO score, is the number that lenders will use to determine how risky it is to loan to you, and the lower your score, the more likely you will get higher interest rates, as the lenders will be looking to protect themselves in the event that you default.

“Your credit score may drop by a few points after a hard inquiry, but it’s only temporary. For example, myFICO says one credit inquiry will take less than five points off your score,” says Howard. “The impact typically lasts a year or two, but it may bounce back quicker if you keep making your payments on time.”

So obviously, don’t go through the pre-approval process unless you are serious about buying a car. But Howard advises that once you’ve had a credit pull, “it’s wise to shop several lenders during a specific time frame so you get to see the best rates,” he says. “Even if you make multiple inquiries, they count as just one if you do them within about 14 days.”

How To Get Pre-Approved

Before you apply to get pre-approved with a lender, Rubenstein suggests taking some time to make sure your financial affairs are in order, and that your credit score is as healthy as possible.

“Potential lenders will evaluate your credit report and credit score, along with your income and debt-to-income ratio, as part of their underwriting process,” says Rubenstein. “Many loan programs do have a minimum credit score, and even if you are approved for financing, a low score will affect auto loan terms. You could end up with a high interest rate and a high monthly payment.

“That’s why it’s important to understand your credit before you shop for a loan and to consider whether it would make sense to hold off on applying for credit until you have improved your credit score,” she adds. “Raising your score from poor (<580) to fair (580-669) could save you more than 50% on a 36-month $25,000 auto loan. Raising it from fair to good (670-739) could save you another 50%.”

If you want the best rates possible, Howards says that “lenders start to offer decent rates with a 680 credit score. If your score is closer to 760, you’re likely getting the same rates as someone with an 840 score.”

If your score isn’t as high as you would like, your first step is to focus on paying your bills on time and perhaps consider getting a debt consolidation loan if you have multiple credit cards or other outstanding debts that are hurting your score. (For more ways to fix a low credit score, check out our article on getting your score higher.)

But sometimes, your credit score is lower than it should be for reasons that are not your fault and that can be fixed. By Federal law, you can get a free copy of your credit report every 12 (they are available for free at AnnualCreditReport.com). Rubenstein says to take a look at your report and make sure there’s nothing that seems incorrect about it.

“Errors on credit reports are surprisingly common. When you review your report, you could find payments reported as late even though they were paid on time, incorrect balances, errors in personal information, duplicate accounts, or even accounts that don’t belong to you,” she says. “Hard inquiries on your credit report that you don’t recognize could be a sign that someone is improperly using your personal information to open new accounts. Review what’s on your credit report to make sure the information is accurate.”

If you find a mistake on your report, contact the three main credit bureaus with documentation about the error, and whatever proof you might have. The bureau will have 30 days to investigate.
Transunion: http://www.transunion.com/credit-disputes/dispute-your-credit
Equifax: https://www.equifax.com/personal/credit-report-services/credit-dispute/
Experian: https://www.experian.com/blogs/ask-experian/credit-education/faqs/how-to-dispute-credit-report-information/

Other Ways To Get Good Loan Rates

Having a solid credit score is the main way to qualify for a great interest rate. But there are other steps you can take as well. Many lenders and dealerships will work with you to find a loan term you will be comfortable with. With longer-term loans, you will have a smaller monthly payment, but you will also have higher interest rates, so you will end up paying more for your car long-term.

“A common misconception is that long loan lengths are a good thing because your payments are typically lower. But that’s not the best move for your wallet,” says Howard. “The max auto loan length should be 42 months. If you can’t afford the payments on a 42-month loan, you should buy a cheaper car.”

In addition to the loan, consider how much money you want to put down for your car. A 20% down payment on a new car and 10% on a used car are both typical. A lender might be able to work with you to lower that amount if necessary, but if you have enough money in your savings to make an even bigger down payment, you will save money in the end.

“Some people are short-sighted about down payments. They assume that a small down payment helps them preserve money for other expenses. Of course, the less you put down in cash, the more you’ll add to the loan, leaving you paying higher finance charges,” Rubenstein. “Before taking on an auto loan, consider how much debt you already have and whether you can afford to make the payments.

“A larger down payment will reduce the amount the lender has to finance and in turn reduce the size of your monthly payments,” adds. “It’s also a lower risk for the lender, increasing your likelihood of approval. For all these reasons, it’s best to set aside money for the down payment before you apply for an auto loan.”