If you’re planning to buy a car, you may not have enough money to buy it outright, or you may prefer to hold onto your cash. A loan can help you finance the purchase, but not all auto loans are created equal.
Before you head to the dealership, it’s a good idea to shop around and compare multiple lenders and their interest rates to ensure you’re getting the best deal available. Here’s what you need to know about the best car loans, how to compare lenders and secure one, and how to refinance an existing auto loan.
On average, car buyers with excellent credit can net an interest rate of 2.47%, according to data from Experian from the fourth quarter of 2021. Even if your credit score isn’t perfect, good credit can give you an average rate of 3.51%, according to the credit bureau. “What constitutes a good auto loan rate will differ per vehicle and borrower,” says Scott Kunes, chief operating officer of Kunes Auto Group.
Since the Federal Reserve has raised interest rates multiple times in 2022, auto loan interest rates have been on the rise with used car rates rising slightly higher.
There are a couple of ways to obtain an auto loan to finance your vehicle purchase. One option is to borrow directly from a lender, and the other is to fill out an application at the dealership and have the dealer arrange your financing.
Direct Auto Loan
With the direct route, here are the steps you’ll take:
- Compare options. Compare between three and five auto lenders and select an offer. Some lenders allow you to get prequalified, so you don’t have to apply to get a rate quote.
- Gather your documents. Lenders may ask for documentation for your identity, income, employment and possibly even your residence. Gather pay stubs, bank statements, tax returns, utility bills and a government-issued ID before you begin.
- Submit an application. You’ll typically need to provide information about the vehicle you’re planning to buy, though lenders may allow you to fill in that information later if you don’t already have a model in mind. You’ll also share how much you want to borrow, your desired repayment term, personal information and more.
- Accept the terms. The lender will let you know how long the underwriting process will take. It may provide you with a preapproved loan amount and terms to take to the dealership, but the loan won’t be finalized until you’ve chosen a vehicle.
- Head to the dealership and find your car. With a preapproval in hand, you can start shopping . Once you find the model you want, notify the lender and finalize the loan.
Dealer-Arranged Financing
One of the nice things about dealer-arranged financing is that the dealer does most of the legwork:
- Bring your documents to the dealership. Because the dealer acts as intermediary between you and potential lenders, you’ll want to bring all the documents to the dealership. These are the same documents you’d provide if you were to apply directly with a lender.
- Choose the car you want. Take your time to shop around and compare models from multiple dealers and choose the car you want to buy.
- Fill out a credit application. The dealership will provide you with a credit application to complete, which it will then provide to lenders with the details of the vehicle.
- Agree to an offer. Ask to see all offers so that you can compare them for yourself. Keep in mind that some dealers give you a higher interest rate than what the lender offers, keeping the difference as compensation. To avoid this, consider getting preapproved before you head to the dealership.
Before you proceed with a lender, it’s important to be sure you’re getting the best deal on your new car purchase. Here are some factors to consider as you shop around:
- Is prequalification available? Some auto lenders will give a quote based on just a soft credit check. If you don’t want a hard inquiry on your credit reports, stick to lenders that offer prequalification. However, if a lender without this option offers lower interest rates, it may be worth it to apply.
- What is the interest rate? Most auto lenders offer fixed interest rates, so you don’t have to worry about rates fluctuating over time. Simply compare quotes to see which lender gives the lowest rate, but keep in mind that prequalification quotes aren’t final. You’ll need to officially apply to get a final offer, but initial quotes can still give you a good idea of which lender will give you a better deal.
- Are discounts available? Some lenders offer interest rate discounts to existing customers. If your bank or credit union can match the rate offered by another lender and give you a discount, that’ll help maximize your savings.
- What are the repayment terms? Auto loan terms can range from three to seven years. Because the term length impacts your monthly payment and how much interest you’ll pay overall, this is a crucial factor to consider as you shop around.
- Are there any prepayment penalties? These fees aren’t as common on auto loans as they are on mortgage loans, but some lenders still charge them. A prepayment penalty is a fee that you have to pay to the lender if you pay off or refinance your loan before a predetermined time.
Depending on your situation, an auto loan may or may not be worth it. “When you’re able to secure a low interest rate,” says Kunes, “a loan doesn’t add much to the car’s total cost, making it a good option for many.”
But even with a low interest rate, it may not be the right choice right now. Here are some of the pros and cons to consider for your particular situation.
Benefits
- You don’t have to save up to purchase a car, which may be necessary for work or school.
- Because auto loans are secured, they tend to offer lower interest rates than personal loans or credit cards, especially if you have excellent credit.
- You can use an auto loan to build and maintain your credit history.
Drawbacks
- Most cars depreciate in value, and if you don’t make a large enough down payment, you could end up with negative equity.
- The lender technically owns the vehicle until you pay off the loan, and it may repossess the car if you default on your payments.
- A car loan is a long-term financial commitment that could impact your financial health if your interest rate or payment is too high.
The only way to get prequalified for an auto loan is to go through the process with a direct lender. As you research, look for lenders that offer options such as, “Get prequalified without a credit check,” or “Get a rate quote.”
Either way, confirm that the lender won’t do a hard credit check before you submit any information.
You’ll typically provide personal details, including your name, date of birth, Social Security number, address, contact details and employment information. With that, the lender may simply let you know that you’re eligible or even provide you with an amount that you can take to the dealer.
Note that your prequalification doesn’t last forever. The lender may give you a deadline by which you need to complete the loan process.
“It’s important to shop around for auto loans before you get to the dealership,” says Mark Reyes, certified financial planner and senior financial advice manager at Albert, a financial services app. “It gives you a negotiating advantage to see what interest rates, terms and loan conditions you qualify for independently.”
Yes, it’s possible to refinance an auto loan that you already have in place. This may be appealing if your credit has improved or market rates have dropped since you took out the loan.
It could also be worth it to refinance if:
- You want to move the loan to your primary bank or credit union.
- You want to adjust the repayment term.
- Your original loan didn’t have favorable terms, but you got an upfront cash incentive from the lender – just watch out for prepayment penalties.
In many cases, auto refinance lenders charge few fees or no fees at all.
If you’re thinking about buying a car but don’t want to take out an auto loan, there are some alternatives available:
- Pay with cash. While cash will help you avoid monthly payments and interest charges, if you can get a low interest rate on an auto loan, you may get more value from that cash by investing it or keeping it in an emergency fund.
- Use your home. Although you may be able to get a low interest rate with a home equity loan, line of credit or cash-out refinance, those options use your home as collateral, so defaulting could risk foreclosure.
- Pay with a personal loan. Unsecured options like personal loans won’t require you to use the car as collateral, but they tend to charge much higher interest rates.
It’s crucial to know for certain that you’re financially able to take on the new debt of an auto loan. “You have to make sure you are financially healthy enough to purchase a car and take out an auto loan,” says Reyes. “This means that you have a solid emergency fund, no toxic debt like high-interest credit card debt, a healthy debt-to-income ratio, and a solid budget that can fit in a monthly car payment.”
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