Getting Preapproved for a Car Loan Has Advantages

Most car buyers prepare carefully for their visit to the dealer, readying negotiating tactics, enlisting a friend to play bad cop and setting a list of must-have options. But many of those same shoppers fail to get per-approved for an auto loan, overlooking a relatively simple step that can save them money through improved loan terms and give them leverage when negotiating with a dealer.

Dealer-arranged financing is not your only option. You are perfectly free to shop for an auto loan at banks, credit unions and other lenders just like you shop for a car. Hitting the dealer’s lot with a pre-approval letter in hand lets you focus on the purchase price, not loan terms. Plus, by leveraging your pre-approval, you’ll be able to squeeze the dealer for better terms instead of letting the dealer squeeze you.

We’ll show why having a pre-approval letter helps you:

• Get a better interest rate
• Clarify your budget
• Simplify your dealership experience
• Get leverage to use in negotiating with the dealer

1. Get a better interest rate

Dealer financing can be convenient, but you’re not likely to get the best deal if you haven’t checked with other lenders first. Dealers have relationships with many banks and finance companies, and when they connect a customer with a lender, they add a markup to the interest rate on the loan. That could mean 1% or 2% or more added to the base interest rate charged by the lender, but the exact amount is typically not disclosed to the customer. You can easily check the auto loan rates offered directly to consumers by banks and credit unions, so you’ll know what the market rates are.

It makes sense to ask for loan rates and terms from several lenders before you commit to one. You can shop for auto loans at banks, credit unions, online lenders and others. Start at the bank where you usually do your checking. As an established customer, you might qualify for discounts such as a quarter- or half-point off the regular interest rate.

Many nonprofit credit unions offer significantly lower rates on new and used car financing to their members, according to National Credit Union Administration data. “I always suggest people start with credit unions. I bought a used car in November and they beat the all the rates offered by the dealer lot or the banks,” says Akshay Anand, auto loan analyst at Kelley Blue Book. You should consider joining a credit union if doing so would give you a significant break on loan terms.

When you find a lender offering affordable rates, fill out a credit application and ask to be pre-approved. Now you have reasonable financing all set, but you can still switch lenders if a better deal comes along.

2. Clarify your budget

Once you’re pre-approved for a specific loan amount and interest rate, you’ll be able to set a realistic budget for your car purchase. Add up your pre-approved loan amount, the value from trading in or selling your existing car, and any down payment you plan to use. Remember to leave room in the budget for taxes and fees, and don’t forget your insurance and other costs that come with owning a car.

MORE: What’s the total cost of owning a car?

3. Simplify the dealership experience

Another good thing about having financing in place is that the dealer will regard you more like a cash customer, someone who has the financial flexibility to walk away at any time.

A common piece of car buying advice is to avoid telling the dealer how much of a monthly payment you can afford. That’s information that the dealer could use against you in negotiations. If you say you’re comfortable with a payment of $450 a month, the dealer might try to persuade you to upgrade to a more expensive model, or add more options, by rearranging loan terms so that your payment remains close to that amount. For example, the dealer could argue that you can easily “afford” extra options while staying at $450 a month if you simply take out a 60-month loan instead of a 48-month loan — while downplaying the fact that you’d spend a lot more money by making those $450 payments for an extra year.

When you’re pre-approved with a lender other than the dealer, you’ll be able to avoid this type of stressful negotiation. You don’t have to discuss monthly payments with the dealer at all. You can leave financing out of the conversation and simply negotiate for the best price you can get.

4. Leverage to use in negotiation

When you bring your pre-approval letter to the dealership, you can ask the dealer to beat those  terms. Even though dealer financing is often more expensive, there are times when that’s not the case. It’s worth filling out a credit application at the dealership to see what special deals and incentives you might qualify for, especially if your credit is good.

Through their relationships with finance companies and automakers, dealerships can sometimes offer very competitive or even zero-percent financing. “I’ve heard of customers with good credit scores in the 700s, even 600s, who got very competitive financing from a dealer,” says Ron Montoya, senior consumer advice editor from Edmunds.com.

As you’re closing the deal, when you’re signing papers in the finance and insurance office, you can use your pre-approval as an easy way to deflect add-ons and extended warranty offers that you don’t want. Just say, “I’m pre-approved for this amount and I’m not going to go over it.”

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