How to Apply for a Car Loan

Applying for an auto loan doesn't have to be complicated -- just be sure to do your homework first.
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It's 7:15 p.m. and you're finally on your way home from work. It's been a long day, but it's not over yet. You still have to pick up dinner and the dry cleaning before you can catch the bus. It's going to be 9:00 p.m. before you get home. As you finally find yourself seated under a pile of packages on the bus, you begin to daydream about having a car. No more taking the bus or train. No more riding your bike in bad weather. No more sitting in the back seat of the carpool -- you could be the one behind the wheel.

Your neighbor just got a cute new coupe. If only you could too. But how would you pay for a car? By doing what most car buyers do -- apply for a car loan. Purchasing a vehicle can be a little overwhelming, especially handling the financing part. But it doesn't have to be. It is possible to navigate the car buying and financing process smoothly. First, you need to have a good understanding of who the lenders are.


If you have an established relationship with a bank or credit union, that might be a good option to consider. Typically, banks have conservative policies and are geared toward individuals with good credit. It can be harder to get a bank loan, but it could mean a better interest rate. As non-profits, credit unions usually have low operating costs, which can mean better interest rates.

A finance company acts as a retailer selling money. It borrows money at wholesale, marks it up and lends it, and it's likely to have higher interest rates. Dealerships offer financing, acting as the intermediary between you and the lender. Buyers beware -- they make money offering this service through fees and markups.

If you own your own home, you can use it to get money through either a home-equity loan or a home-equity line of credit. Usually these loans have low interest rates and may be tax-deductible. However, should your home's value drop and you sell, you're responsible for repaying the home-equity loan, even if you don't make that money back. With a home-equity line of credit, you'll likely have prepayment penalties and a lien on your home until it is paid. In a lien, the lien holder (the lender) has first right to that asset until the lien is satisfied.

Now that you know who the lenders are, it's time to consider your credit.


Auto Loan: Get Your Credit in Check

The moment you decide a loan is in your future, check your credit. Your credit score, also known as a FICO score (Fair Isaac Corp. for the organization that founded the system) predicts your likelihood to repay a loan. Scores range from 300 to 850, with the average American having a score of 675. A top-tier score (or prime) is 700 to 850, near-prime is 620 to 700 and subprime is less than 620 [source: Buss].

How do you know where you fit? Check out your credit report from the three main credit bureaus -- Equifax, Experian and Trans Union. Thanks to the Fair and Accurate Credit Transaction Act, you can obtain a free report annually from each of the bureaus. Visit to get started. You can get an idea of your credit standing via the report, but for the actual score, you'll need to pay a fee. If you are married and your spouse will be on the loan, be sure to check his or her score as well.


If you find that your score needs some improvement, try the following:

  • Correct errors directly with the credit bureaus: There is a 50 percent chance of having a mistake on your report. Correct any errors and follow up to make sure the corrections are reflected on your report. It can take 60 to 90 days to have outdated information corrected [source: Bankrate, Inc.]. Also, bureaus must be able to support bad marks on your credit. Ask for proof.
  • Contact the company you have a dispute with: If there is a mistake with a specific company, contact that company with supporting documents and ask your contact to send corrected information to the appropriate bureau.
  • Support your case: Include a brief description of your side of a dispute in your report.
  • Improve your behavior: Make payments on time. Pay off cards with high balances. Close some, but not all, of your old inactive accounts; the bureaus want to see that you have credit available. Keep older accounts with good history. Don't open cards or go over your limits. Avoid large bills on credit cards, including corporate cards.

In addition to your score, your profession, proof of employment, home ownership and the ability to justify any issues on your report can also enhance your credit worthiness.

Now that you've taken this important step in the loan process, it's time to determine how much you can afford.


Auto Loan: What can you comfortably afford?

Determining how much you can afford to pay is the most important step when considering a car purchase and applying for a car loan. In general, you should not spend more than 20 percent of your take-home pay (the amount on your paycheck, not your original salary) on all of your household's vehicles -- that means your car, your spouse's car and that old convertible tucked under the tarp in the garage. The exception to this standard might be a graduate just coming out of college who is living rent-free with family or friends but does have a steady, if entry-level, salary [source: Booth Hubbard].

Now before you start having visions of a fully loaded luxury SUV, keep in mind that a lot factors in to the 20 percent rule beyond the purchase price of your car. You need to consider how much money you can put down, the loan's interest rate and other factors. All of this adds up to the true cost of ownership, which includes:


  • Depreciation: Cars are a depreciating asset; they lose value as they age.
  • Interest rate: This is the annual interest fee applied to your loan.
  • Insurance premiums: Find out how much your insurance will cost. Different types of cars may have higher insurance premiums than others do, especially if repair costs tend to be higher.
  • Fuel: Consider which grade of fuel your vehicle requires. How far will you be driving each week? How much gas will you need?
  • Taxes and fees: You'll be paying sales tax and fees to register your car with the state as well as annual property taxes.
  • Maintenance: Maintenance on vehicles varies, and there is not a tried-and-true way to gauge these costs -- but keep in mind things like oil changes and new tires.
  • Repairs: Repairs might not be an issue for new cars, but over time and with pre-owned cars, repairs will have to be factored in to your budget.
  • Federal tax credits: Are there any government incentives available for purchasing a certain type of car?

All of these calculations and factors may seem daunting, and no doubt there is math involved. However, there are lots of tools online, including payment calculators.

If you've used one of those calculators and you're ready to go shopping, don't go just yet; you can still do a bit more homework to streamline the process.


Auto Loan: Planning and Organizing

When you are in the market for a new vehicle, consider shopping for your loan separately. Prequalifying for a loan allows you to go into a deal with funds already lined up, which means financing isn't a discussion point until after you have most of the deal already worked out. Then, you can also bargain with the dealer for financing options. After all, you already have a loan lined up.

Don't know where to start? Follow these steps:


  1. Spend two weeks shopping for your loan. Each time you apply for a loan, the financing organization will pull your credit, which can have a negative effect on your score. However, all of the inquiries that take place in a two-week window count as just one [source: Dratch].
  2. Potential lenders will request different documentation. To facilitate the process, have the following ready: proof of income, credit and banking history, proof of residence, vehicle information (if you couldn't help yourself and went car shopping first) and proof of insurance.
  3. Fill out the loan paperwork yourself so you can ensure everything is correct.
  4. Pay attention to the total loan amount. Don't lose sight of what the total loan amount is. Some lenders may encourage you to spend more on the loan by simply extending the term, which decreases your monthly payments.
  5. Once you receive the loan proposal, don't assume the lender has offered you the best possible package. Let the lender know you are applying with other organizations. Avoid conditional financing, which means that you might not be locked in to your quoted loan.
  6. Use online tools to compare loans.
  7. Read your paperwork. Remember, this is a binding agreement. Watch for any language about binding arbitration, which might mean you can't go to court over a dispute. Make sure the contract includes everything you have been promised.
  8. Check the math.
  9. Check your lender through your local attorney general's office, Office of Consumer Affairs or Better Business Bureau.

Keep reading for a handy checklist of questions to ask potential lenders.


Auto Loan Check List: Questions to Ask Your Lender

With loan shopping, you might feel you are the only one on the spot, but that's not true. Just as much as lenders are looking at you, you are interviewing them. Be prepared with your own list of questions:

  • What supporting documentation do I need?
  • Do you require me to purchase a vehicle through a licensed dealership?
  • How long will the process take?
  • What factor will my credit rating have?
  • What should my down payment be? Do you require a set amount?
  • What is the trade-in value on my car? (This question is relevant for dealer financing only.)
  • What would my base interest rate be? Will it ever change? Is that the best rate available? (Your base rate is the total yearly interest rate applied to your loan.)
  • To secure this rate, do I have to pay points? (Points are a percentage of the loan the lender may charge you as a fee.)
  • Over the course of the loan, how much interest would I end up paying?
  • What will my APR be? (APR stands for annual percentage rate and includes the base interest rate and any other costs associated with your loan.)
  • What fees are included?
  • What would my monthly payments be and for how long? At the end of my term, will a lump sum payment (typically a larger final payment) come due? Can I lock in on the quoted rates/points? Is there a fee to lock in? (Locking in means the lender keeps your interest rate and points firm for a certain amount of time.)
  • Can I make payments early without penalty?
  • Can you require full payment of my loan and why?

[source: Lending Tree]


For more information on auto loans and other personal finance topics, visit the links on the following page.


Lots More Information

Related HowStuffWorks Articles


  • Automobile Magazine. "Auto Loan Application." (January 10, 2010)
  • Bankrate, Inc. "Auto Financing Basics." May 1, 2006. (January 10, 2010)
  • Booth Hubbard, Sylvia. "How much car can you afford?" Bankrate, Inc. January 20, 2005. (January 10, 2010)
  • Buss, Dale. "How to Get an Auto Loan During the Credit Crunch." Edmunds Inc. (January 10, 2010)
  • ConsumerGuide Automotive. "Expert Automotive Advice." (January 10, 2010)
  • "Auto-financing alternatives." June 2009. (January 10, 2010)
  • "Where to shop for an auto loan." April 2009. (January 10, 2010)
  • Dratch, Dana. "10 Steps to your best deal on a car loan." Bankrate, Inc., Winter 2009. (January 10, 2010)
  • Edmunds Inc. "How Much Car Can I Afford?" (January 10, 2010)
  • Edmunds Inc. "True Cost to Own." (January 10, 2010)
  • Grant, Kelli B. "New Versus Used Car: Six Factors to Consider." SmartMoney. April 8, 2009. (January 10, 2010)
  • Lending Tree. "Auto financing options." August 6, 2007. (January 10, 2010)
  • Lending Tree. "Car refinance: Does it make sense for you?" August 6, 2007. (January 10, 2010
  • Lending Tree. "Checklist: Auto Loan Documentation." August 6, 2007. (January 10, 2010)
  • Lending Tree. "Checklist: Questions to ask your auto lender." August 6, 2007. (January 10, 2010)
  • Lending Tree. "How to get a car refinance loan." August 6, 2007. (January 10, 2010)
  • Lending Tree. "What to ask before you take out a loan." August 6, 2007. (January 10, 2010)
  • Reed, Philip. "True Cost to Own (TCO)." Edmunds Inc. (January 10, 2010)