While some people may be able to pay for their vehicles with cash without financing an auto loan, it is far more common to make such a large purchase based on credit with monthly payments. As with any loan, the lender will need to decide whether they will give you the loan based on whether they think you will pay it back. This decision is fueled by factors such as the car itself, its value and age, and your personal financial history.
Down Payment
Some lenders, either banks or car dealerships with their own financing programs, will require that you make a down payment on the vehicle you intend to finance. This shows the lender that you are taking a financial interest in the vehicle from the beginning of the transaction, and that you are less likely to default on the loan. A down payment also ensures that if you were to not make your loan payments, the value of the car is more than the value of the loan and the lender would be able to recoup their interest in the vehicle fully. Down payment is usually required to be a certain percentage of the value of the car, and requirements may vary, so it is best to contact the lender you wish to use to find out their specifications. If down payment is not a requirement you would like to comply with, you may consider financing the car with a home equity loan, which automotive website CarClicks.com states is an increasingly popular option.
Car Value
Most creditors who do auto loans on a regular basis will have a system for evaluating the value of the vehicle they are about to finance. They will often ask you to tell them all of the specifics on the car; stereo system, power options, extras, upholstery type, etc. This is so that they can get a more accurate estimate on the value of the car. The value likely will be required to be either more than or equal to the amount you are looking to obtain from the loan. This means that you will start out with equity in the car, and can either be accomplished by obtaining a good deal on a highly valued car or by placing a down payment on the vehicle.
Age of Vehicle
While most car dealerships will extend financing for any car on their lot, some banks and other lenders will have restrictions on exactly how old the car can be. For instance, U.S. Bank has a requirement that vehicles it finances not be more than seven years old. While this is not a consideration if you are financing a current model vehicle, if you are shopping for a used car, it may be helpful to ask your intended creditor whether it has a maximum age for cars they are willing to finance. If there is a requirement in place, you can either adjust the age of the cars you are looking at to compensate or find a lender with a looser restriction.
Income
In terms of your personal financial situation, one of the most important factors evaluated by your lender is likely to be your monthly or annual income. They will want your income to demonstrate that you have the ongoing ability to make payments on the loan, and will want you to provide documentation that supports your income. Acceptable proof of your income usually consists of copies of your pay stubs, tax returns or W2s.
Debt to Income Ratio
Lenders will also evaluate the ratio between your monthly income and your monthly debt obligations to determine whether or not there is room in your income to support an additional payment. The creditor will ask you to tell them the amount of any monthly payments you have, such as your mortgage, credit card payments and current car payments. This amount will then be divided by the amount of your gross monthly income, and if the result is under a certain threshold --- determined by the financier --- you are considered credit worthy.
Credit
The final aspect of the lender's evaluation will be your credit report, which the lender will retrieve from one of the three credit bureaus. This report will contain a credit score and a credit history, showing any patterns of late payments or defaults on credit obligations. If you have any derogatory entries on your report, you may be able to explain the circumstances to the loan officer and have them weigh less on the credit decision.
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