How Does an Auto Loan Pre-Approval Work?

by Valencia Higuera

    If you're thinking about financing a new or used car, an auto loan preapproval is an important step in the process. An auto loan preapproval is not required when financing a car, but with your financing in place before shopping, you know what you can afford to spend. The lender will need specific information from you. Once you supply this information, the preapproval process takes about 24 hours — sometimes less. Auto loan preapprovals are valid for up to 60 days, according to Bankrate.com.

    When you're ready to get preapproved for an auto loan, several options are available to you. You can visit a dealership and submit a loan application with the dealership's finance department. Understand, however, that if you're preapproved through a dealership, you would need to purchase your car from that dealership. If you don't want to limit yourself, get preapproved from a bank or credit union. You can submit a loan application with these financial institutions, but purchase your car from any dealership. An outside lender will review your application, determine how much you can afford to spend on a car and decide your interest rate. Banks and credit unions typically charge less interest. A preapproval from a bank or credit union is also a bargaining chip. Since bank rates are typically lower, the dealership will have to beat your current rate if they want to provide your financing, according to Bankrate.com.

    A bank, credit union or dealership will not preapprove your auto loan application before verifying your income. The application will ask you to state your gross monthly or annual salary. In addition, the financial institution will request proof of your income. This might include your most recent paycheck or two years worth of tax returns if you're self-employed. Other documentation that can serve as proof of income include statements highlighting retirement income, disability income, alimony and child support.

    The financial institution will also verify your credit before preapproving your auto loan application. Income alone isn't enough to qualify for an auto loan. The bank has to assess your payment habits and debt-to-income ratio. This is the percentage of your income that goes toward debt payments. A healthy debt-to-income ratio is about 36 percent, according to CarsDirect.com. You may earn a sizable income, but if you have a lot of debts and little disposable income, the bank may not approve your loan application. Likewise, the bank may deny your application if you have frequent late payments, collection accounts and judgments on your credit report. However, some lenders do offer bad credit or subprime auto loans. A credit score below 680 can place you in the subprime category, according to CarsDirect.com. In this case, you will pay a higher interest rate on your auto loan.

    When shopping for an auto loan, it pays to contact multiple lenders and compare interest rates. You can obtain multiple preapprovals, and this will not hurt your credit score. While multiple credit applications or inquiries can hurt your score, credit scoring systems are able to decipher when multiple applications are due to rate shopping. In this case, all auto loan applications that occur within 30 days of a credit score recalculation only count as one inquiry, according to Bankrate.com.

    About the Author

    Valencia Higuera is a freelance writer from Chesapeake, Virginia. She has contributed content to print publications and online publications such as Sidestep.com, AOL Travel, Work.com and ABC Loan Guide. Higuera primarily works as a personal finance, travel and medical writer. She holds a Bachelor of Arts degree in English/journalism from Old Dominion University.

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