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Updated May 13, 2020
Shopping for an automobile can be an exciting yet exhausing experience. It’s fun to drive off the lot with a new car, but the preparation beforehand can be stressful.
On way to prepare finanically is getting a car loan before you shop. While some drivers can afford to pay for a car up front, most choose to finance their car, which includes taking out an auto loan and then paying back the loan over time, with interest.
How does an car loan work?
An auto loan works much the same way as other types of loans. You take out a car loan through an institution, like a bank or the auto dealer where you’re getting the car. That institution agrees to loan you money to buy the car, and you agree to pay back the amount you borrowed through monthly payments, plus interest. You can learn more about how auto loans work here here.
Regardless if you're buying a new or used car, you will almost always be better off lining up your own financing instead of relying on a dealership. Here are four reasons to apply for an auto loan before you shop for a new ride.
If you apply for auto financing once you’ve selected a car, you’re stuck picking from the lenders and loans the car dealer offers. This often means choosing from a handful of lenders at most, and it could mean not having access to loans with the best rates and terms.
By shopping for an auto loan early, however, you can compare loans from several lenders to ensure you get the best deal. To save time and effort, you could shop for an auto loan on a website that offers multiple quotes and several offers in one place. While shopping for the best loan, compare the annual percentage rates, fees, monthly payments and repayment timelines.
Read more about the pros and cons of dealer financing.
Another benefit of applying for a car loan beforehand is the ability to set a realistic budget before you shop. It’s easy to be wowed by a car outside your price range if you don’t set a budget ahead of time. Having a preapproved loan offer can keep you on track.
Figure out what you can afford. Look at your monthly budget, your expenses and your savings goals, then determine how much you can pay for a car each month without sacrificing other financial goals. In addition to your monthly payment, consider the costs of auto insurance, maintenance and repairs.
Many car sellers focus on getting you to spend as much as possible, and they use your ideal monthly payment to push the limits.
Let’s say you want to spend $10,000 on a used car. You begin to shop without a preapproved loan offer, and the sales agent asks you what monthly payment you can afford. You tell him $300 per month — the amount of your old car payment.
All of a sudden, the salesperson is showing you cars in the $20,000 range. Why? Because, if you took out a 72-month auto loan for $20,000, your monthly payment would only be $317.48 at 4.5% APR.
With a preapproved auto loan, you won’t fall victim to these tricky marketing techniques. You already know how much you can spend and how much you’ll pay each month, so you can shop for cars within your budget.
When you have the cash or a preapproved loan check, you can negotiate a cash sales price without getting caught up in the minor details of auto dealership financing. This will make your negotiation less complex.
While it’s fine to shop for cars in your price range before you know what you want, you should research prices on websites like Kelley Blue Book before you negotiate.
With a preapproved auto loan check or cash in hand, you can research average sales prices for the car you want to buy then make a take-it-or-leave-it offer. If the dealership doesn’t like your offer, you must head to another dealership and start again.
With preapproval, you already know what you can afford and you have a auto loan to prove it. With that leverage, you’re in the ideal spot to get the car you want for a price you can afford.
Further reading: Already have a car? Here's how to refinance your car loan.
Image: Arslan Ozgur Sukan
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