Deciding it's time to finally finance a car can be a big step. Before you get overwhelmed by the big picture, we're here to walk you through the process of getting your first car loan step by step.
Take a Step In the Right Direction
The steps you have to take, and the order you take them in, largely depend on what type of auto loan you qualify for. So before you can set out on the path toward your first car loan, you need to know your starting point. This means getting familiar with your credit situation – both your credit score and credit reports.
Step One: Know Your Credit
To begin any auto financing journey, the first step is to find out your credit score and know what’s on your credit reports. There are several ways you can do this, but the easiest way right now is to log on to www.annualcreditreport.com, where you can receive a free copy of your credit reports from each of the three major credit bureaus once a week until April 2022.
Typically, you can obtain your credit score through your bank or credit union, credit card company, or any number of online resources. Once you have your credit score in hand and know what is on your credit reports, you should be able to classify yourself into one of three categories – good credit, bad credit, or no credit.
As a first-time car buyer, it’s likely that you’re going to be considered a no-credit borrower, which is used to describe borrowers with thin credit files.
Where your credit score falls determines the type of auto loan you qualify for and what type of lenders you may find yourself working with.
Step Two: Build a Budget
Almost as important as knowing what's on your credit reports is knowing how much you have to work with financially. Your budget includes much more than just the cost of your car loan payment, so it's important to know how to compare your income to the bills you pay, just like a lender’s going to.
Two different formulas are used to calculate how much auto loan lenders think you can reasonably handle. They determine your eligibility by looking at your debt to income (DTI) and payment to income (PTI) ratios. Your DTI shows them how much of your gross monthly income (pre-tax) is already being used to pay for other things such as student loans and/or mortgage payments. Your PTI shows how much of your income is being used by your car loan and insurance. If your budget is already stretched thin you're not likely to qualify for financing.
Most lenders cap DTI at 45% to 50%% of your income, and PTI at around 15% to 20%. The lower the better in both cases.
Don't forget to take into account that once you have the car, you're also going to be responsible for the cost of insurance, maintenance, fuel, and any upfront fees on your loan cost, such as a down payment.
Down payments aren't always required if you have excellent credit, but for most other borrowers, you're not likely to get off a dealership lot without making one. As a bad credit borrower using a subprime lender, there's generally a down payment requirement of at least $1,000 or 10% of a vehicle selling price.
Step Three: Research Your Lender Options
When you know what your credit and budget constraints are, you can start to look for a lender that meets your needs. Not all lenders can work with all borrowers, so your choice may be limited by your credit score.
Typically, there are three types of lenders that may apply to your car buying situation, even if you're a first-time buyer:
Direct lenders – These are lenders who work for financial institutions, such as your bank or credit union. The auto loans generated by direct lenders tend to be reserved for borrowers with better credit scores. Additionally, if you qualify, you can use your pre-approved direct loan at any dealership, or for a private party purchase. These loans tend to have lower interest rates, as they typically go to people with higher credit scores (credit score is the largest factor in determining auto loan interest rates), and if you're a bad credit borrower, you may have more luck if you're a long-standing member of a credit union.
Indirect lenders – These lenders are behind-the-scenes players, and you typically work through the finance and insurance manager at a dealership, who acts as your middleman. These are the loans you get when you walk into a dealership, find a car you want, and apply for financing right then and there, or you get financing first then choose a vehicle. These lenders know that you have to start somewhere, so they look at more than just credit scores to get borrowers qualified for car loans. Typically requires you to provide proof of income, residency, and a working telephone, along with personal references and down payment.
In-house financing – Where indirect lenders may look beyond your credit score, in-house financers may not use it at all. These lenders, also known as buy here pay here (BHPH) or tote the note lots, and are often a go-to option for first-time buyers, who think they don't have enough credit for a traditional or even subprime loan. Not all BHPH lenders operate the same way, so be sure to find out the details before you sign a contract. Some in-house financiers charge a higher than the average interest rate and may require a down payment of up to or around 20% of the vehicle's selling price.
Step Four: Find Financing
As a first-time car buyer, you're likely to have a lower auto-financing credit score. This isn't a bad thing for the right type of lender – everyone has to start somewhere! However, not all lenders feel the same. You're more likely to qualify for an auto loan if you stick to the lenders that know how to work with borrowers getting their first car loan.
Your credit is a record of your financial life in the world of credit, recording all the loans, and debts you take on over your lifetime. Most credit information typically has a seven-year lifespan, and "falls off" your credit reports after that amount of time. The information in your credit reports generates your credit score.
Your score can vary depending on the credit scoring model used by a lender. However, most lenders use the FICO credit scoring model. This model ranges from 300 to 850 and groups borrowers into tiers based on score.
Since you've never financed a vehicle before, there's no auto loan information from your past for the lenders to judge how you might handle vehicle financing, so you're likely to be considered as having a thin file. This may make some lenders wary to extend financing to you, however, there are other lenders, called subprime lenders, that specialize in working with borrowers that have unique credit situations.
We Want to Help
At Auto Credit Express, we have a nationwide network of special finance dealerships that have the lending partners you need. Don't put undue stress on yourself over your first car loan! We want to help make your search for the right kind of lender possible. Simply fill out our fast, free, auto loan request form, and we'll get to work finding a dealership in your area.