What Factors Affect the Car Loan Approval Process?

When buying a car, most people need to finance the purchase. So, for many, the quality of their car buying experience hinges on how well they navigate the loan approval process. There are several layers and moving parts in the process, which, if not properly addressed, could add hundreds or thousands of dollars to the cost of buying a car or result in a flat-out decline.

Here are the key factors lenders consider in deciding whether to approve a car loan:

Credit Score

Your credit score is a key measure of your creditworthiness; in other words, your reliability in repaying a loan within the terms provided by the lender. The difference between a great credit score (700 plus) and a less than great score can mean the difference between favorable terms and a high-interest loan costing thousands of dollars more. Before applying for a car loan, you should take the necessary time to do everything possible to improve your credit score as much as possible.

Debt-to-Income Ratio

The debt-to-income ratio (DTI) measures your financial capacity to repay a loan. If you have too much existing debt in relation to your income, you may be considered a risk to the lenders. Your DTI compares your total monthly debt payments to your income. The higher your DTI, the more your income is being used to pay your debt, putting you under greater financial stress.

To calculate your DTI, add all your debt payments together, including your mortgage or rent, credit card payments, car payments, and student loan payments. Next, add up your sources of monthly income, then divide your total monthly debt payment by your total monthly income, and you have your DTI ratio. If your ratio is much over 35 percent, you could be considered a high risk. At that point, you should be doing everything possible to reduce your debt payments or find a way to bring in more income.

Size of Loan and Down Payment

Your credit score and DIT are used to determine how much a lender can comfortably loan you and how favorable the terms will be. The higher the loan amount and the smaller your down payment, the more a lender will scrutinize your risk factors. Lenders will look more favorably on your application when you can put at least 10 percent down on the loan.

Age of the Vehicle

You are likely to receive more favorable terms for a new car loan because, if you default on the loan, the car will have a higher resale value should the lender need to repossess it.

Length of the Loan

Loans with shorter terms are less risky to lenders, so they tend to come with more favorable terms. If you try to stretch your loan out beyond four or five years, the lender will want to offset the added risk with a higher interest rate.

The bottom line is before you apply for a car loan, you should do everything possible to get your financial houses in order. By understanding the key factors lenders consider in approving a loan, you can direct your focus to the ones that are most likely to earn you more favorable terms.