When you apply for an auto loan many financial institutions will look at your ability to purchase, the car or truck you want to buy, and the amount you want to finance relative to the vehicle’s value.
While there is no single formula that all banks and credit unions use to evaluate an auto loan application, these three criteria or factors are the most important, according to Austin Cegnar, finance manager at Maverick Car Company in Boise, Idaho.
Ability To Purchase
The loan officer at a bank or credit union wants to be confident that a borrower has the ability to pay back the vehicle loan. This “ability to purchase” will be based on the buyer’s:
- Income stability – how long he or she has been in a job or owned a business, as examples.
- Outgoing expenses – the buyer’s total monthly expenses as a percentage of total gross income.
- Personal credit history – the combination of credit score and history.
The Vehicle
The car or truck you want to buy makes a difference in how a bank or credit union evaluates your car loan application for at least two reasons, including how likely you are to complete the loan term and how much the vehicle is worth.
Loan Completion
Banks will consider how likely the car or truck being financed is to either breakdown or be traded in before the end of the loan’s term. This is why some lenders have relatively higher rates on older vehicles with high mileage. To understand why this is important, remember two things.
- From the bank’s perspective lending money has an inherent risk. There is the chance a borrower won’t pay.
- Bank’s offset this risk by making a profit on the loan via interest.
Vehicle Value
How much a car or truck is worth, also makes a difference when you’re applying for an auto loan.
Financial institutions have costs associated with lending money. When someone borrows $30,000, the bank or credit union expects to earn more than enough interest to offset both the risk (mentioned above) and any of its fixed costs. But if the loan amount is only $3,000, it might not make financial sense for a bank or credit union to offer the loan at the same terms.
Ratio Of Amount Financed
Finally, most lenders only want to finance the actual value of a vehicle.
Banks and credit unions use sophisticated software to determine the current value of a car or truck. This valuation is based on the car’s vehicle identification number (VIN) which identifies its powertrain, trim packages, and similar, and a careful consideration of any accessories or additional equipment.
Let’s imagine that we have a hypothetical buyer, John, who wants a vehicle that has a current value of $14,000. The dealership’s asking price is $13,795 which is slightly less than actual value.
When sales tax and documentation fees are added, the total cost of the vehicle comes to $14,950, which is about 107-percent of the vehicle’s current value.
A bank may make that loan based on John’s creditworthiness, or it may ask for money down. Putting $1,000 down in cash, lowers the amount financed to $13,950, which is less than the car’s current value. This lower’s the bank’s risk and may provide better terms for John.
Getting Approved For Your Auto Loan
Now that you recognize how a financial institution evaluates your car loan application, you should have a better idea of how much you can spend on your next car.
If you would like more specific information, including understanding the difference between a soft or hard credit pull, please contact us at Maverick Car Company. We are glad to help.