If you’re in the market for a new car, expect an average transaction price (ATP) of over $42,000. That’s the ATP of light vehicles in the US as of June 2021, an increase of more than $2,500 than the previous month.
Those exorbitant prices, in turn, are pushing car buyers to take out larger car loan amounts. In fact, outstanding auto loan debts jumped from $8 billion to $1.38 trillion in the first quarter of 2021 alone.
However, that increase doesn’t mean lenders have relaxed their car loan requirements. On the contrary, some may even have tightened their standards. Either way, it pays to know what these requirements are so that you can boost your odds of getting a yes from a lender.
We’ll walk you through the most common auto loan requirements in the US, so be sure to read on.
A Good Credit Score
Federal data shows that the median borrower credit score of auto loans originated in Q1 of 2020 was 720. What’s more, only 15% of all new car loan originations were for borrowers with credit scores lower than 620. Many other types of loans, such as home loans, also showed higher credit score standards.
For that reason, it’s imperative to have a good credit score to raise your chances of qualifying for a car loan. Good credit scores range from 661 to 780, and anything higher than that is an excellent score. By contrast, a fair score ranges from 601 to 660, a poor score is between 500 and 600, and anything lower is very poor.
Unfortunately, only 69% of creditable US consumers had a good or higher credit score in 2020. If you’re not part of this group, it’s best to improve your score before applying for an auto loan. Otherwise, lenders are likely to reject your credit application.
Paying down outstanding loans and credit card debts can help boost your credit score. That’s because the lower your total debts, the lower your credit utilization rate, too. This rate, in turn, accounts for 30% of your credit score.
Moreover, the more debts you pay off, the better your payment history. This factor accounts for 35% of your credit score, so any payment, be it big or small, is beneficial.
Verifiable Proof of Income
Because you’re borrowing money to buy a car, you need to prove to lenders that you can pay it back.
For that reason, you have to show them proof of employment or income, such as recent pay stubs or a W-2 form. If you’re a self-employed borrower, lenders may require you to submit bank statements. If you’re getting 1099 income, be sure to prepare two to three years of your tax returns.
Proof of Identity
Auto lenders require proof of identity to avoid identity theft and fraudulent transactions. After all, these crimes are rampant in the car lending industry. For example, in 2020, Equifax reported 210,000 potential identity fraud cases.
So, be sure to prepare a few government-issued identification cards. Your state driver’s license, Social Security card, and passport are some examples.
Proof of Residency
Lenders require proof of residence to determine how stable your living conditions are. For example, if you have a permanent address, lenders are likely to consider you less of a flight risk. By contrast, they may be less willing to lend you money if you tend to move from one place to another.
In addition, lenders need to confirm where you live to know where they can find the car they financed. Remember: auto loans are a secured form of loans, so lenders can “repossess” cars with unpaid loans.
Fortunately, it’s easy to prove where you live with utility bills or bank statements. However, be sure to prepare only the most recent ones, such as this or last month’s bills or statements.
Most car lenders require a down payment from borrowers. The actual amount depends on lenders, but the general guideline is to pay down at least 20% of the car’s price. So, if the vehicle you want to buy is worth $40,000, it’s best if you can put a down payment of at least $8,000.
It’s important to pay down as much as you can outright to reduce the amount you need to borrow. Otherwise, you may end up borrowing more than you can afford. Note that this habit is also one of the top mortgage, personal loan, and title loan mistakes many folks make.
If you don’t have enough cash for a down payment, gauge your circumstances to see if you can afford to wait. If so, then save as much as you can before you apply for an auto loan. If not, consider buying a car that has a lower average transaction price.
Full Auto Insurance Coverage
All states have motor vehicle financial responsibility laws. In the majority of states, auto insurance satisfies most of these rules. So, whether you’re buying a car with cash or financing it, you’d need car insurance.
However, lenders have to cut their risks, so most require borrowers to carry full coverage. This should include coverage that meets your state’s minimum requirements. On top of that are the mandatory comprehensive and collision coverages.
You can get full coverage from the auto dealership where you plan to buy your car. You can also purchase it from one of your existing insurers. If you have a homeowner’s policy, ask your provider about car insurance, as you may get a bundled discount.
Either way, most lenders require proof of insurance before they grant a loan. So, shop around and compare policies even before you send your loan application.
Prepare These Car Loan Requirements before You Apply
There you have it, your ultimate guide on car loan requirements in the US. As you can see, most of them have to do with your creditworthiness and financial standing. So, it’s best to boost your credit score and strengthen your finances before you apply for an auto loan.
Interested in enhancing your financial literacy with more guides like this? Then feel free to check out our other money-related blog posts!