How a Lender sees You for an Auto Loan

The dream of owning a car can feel particularly challenging for middle-income buyers who are either building their credit from scratch or have some bumps in their past payment history. It’s easy to feel discouraged, but understanding how auto lenders evaluate applications may help you understand their logic and can help you to navigate the process of getting the best Auto Loan outcome. 

Let’s break down how auto lenders assess buyers with limited or imperfect credit, focusing on the core factors and providing clear examples:

Your Past Credit History: Building from the Ground Up or Addressing Past Stumbles

This is often the biggest hurdle for those without established credit or with prior late payments. Lenders rely heavily on your credit report to predict future behavior.

• No Established Credit: If you’re new to credit, you won’t have a long history for lenders to review. This can make them hesitant, as there’s no track record of how you manage debt.
  • Example: Sarah, a recent graduate with a stable entry-level job, has never had a credit card or loan. When she applies for an auto loan, the lender has no information on her payment habits.
• Prior Late Payments: Past late payments, even seemingly minor ones, signal a higher risk to lenders. Multiple late payments or more serious delinquencies (like collections or defaults) will limit the number and type of lenders that will be willing to provide credit. .
  • Example: Mark, a skilled tradesperson with a steady income, had a period of financial difficulty a few years ago, resulting in a few late credit card payments and a default on a personal loan reported on his credit.

How Lenders Approach This:

• No Established Credit:
  • Emphasis on Other Factors: Lenders will look for positive attributes that demonstrate a willingness and ability to make the loan payment, such as your income level and employment stability to compensate for the lack of credit history.
  • Down Payment Importance: Down payment becomes front and center showing your commitment to the vehicle and lowering the loan amount relative to the value of the vehicle, reducing the loan-to-value ratio. The higher the down payment, the better both of these will be. Think about it from the lender’s perspective: Would you want to lend someone you don’t know without any prior payment history more than the value of the car they are buying?
  • The Right Car and Payment: Is the price of your first car too much and going to stretch your ability to pay? Is it a luxury car that may result in higher insurance and risk of a large maintenance bill? The odds you are able to make the payments and repay the loan go up considerably if the loan payment doesn’t exceed 10% of your gross monthly income. So if your monthly gross income is $5,000, lenders will like to see your loan payment $500 or below. Also, make sure the sales price you are agreeing to isn’t higher than the market value because more of the down payment will just be getting you back to what the price should be. 

All three of these elements work together. A large down payment on a more expensive car can be a net negative. From a lender’s perspective, you will in a favorable position to obtain a loan purchasing a reasonable car for your income at a price somewhat below market value, and put down 20%. 

• Prior Late Payments:
  • Severity and Frequency: Lenders will assess the severity and recency of your late payments. A few late credit card payments from a couple of years ago will be viewed differently than recent or recurring late payments or a prior auto repossession and will correspondingly impact your score in the same way. 
  • Prior Auto Loan History: If you have had an auto loan in the past, lenders will often put more weight on how you paid it relative to other bills. 
  • Higher Interest Rates: You will likely face a higher interest rate that can be improved on with not stretching to purchase too much car, negotiating a sales price that is at or below market, putting 20% down, and keeping the monthly payment under 10% of your monthly gross income. 
  • Larger Down Payment: The higher the down payment, the better. It shows commitment to the vehicle and lowers the loan amount – assuming the same pricing on the car – and helps offset the perceived risk associated with your past payment issues.
  • Focus on Recent Positive History: Lenders will look for signs that you’ve improved your financial habits since the late payments occurred. Have you missed any payments over the past 12 months? If so, the few lenders that provide a loan would require a much higher interest rate. 
  • Stability of Your Income: Did you just start a new job? The longer you have been with your employer, the better. Did you earn a lot of overtime recently? Since your loan term will likely be around 72 months, lenders may not consider all of your overtime pay as income while budgeting how affordable the new payment will be. 

Your Income: Showing You Can Handle the Monthly Payments 

For middle-income buyers, demonstrating a stable and sufficient income is crucial, especially when credit history is limited or imperfect.

How Lenders Approach This:

• Verification is Key: Lenders will rigorously verify your income through pay stubs, your bank statements, and directly verifying with your employer that you still work there and your starting date. It is becoming more common for lenders to request access to your checking statements through a service called Plaid, which is entirely safe. 
• Stability Matters: Consistent employment with the same employer for a significant period is viewed favorably. Some lenders will require minimum time with your employer, often 12 months. 
• Payment-to-Income (PTI) is Often the Most Important: At the end of the day, are you able to afford the monthly car payments? From a risk perspective, this is the most predictive attribute of how you will perform in the new auto loan. Obviously the lower the better. 10% is a good target and anything over 14% begins to increase the risk you are able to make the loan payments substantially. 
• Realistic Loan Amounts: For middle-income buyers, lenders will likely be more cautious about approving very large loan amounts that would result in high monthly payments relative to their income, higher insurance cost, and higher risk of a repair bill that increases risk that you can both pay for the the repair and make your payments. 

How Much of a Loan Do You Need Relative to the Value of the Car: Minimizing the Lender’s Risk

For lenders, the loan-to-value (LTV) ratio is particularly important for buyers with credit challenges because it determines how much the lender will lose if you stop making payments and the lender repossesses the vehicle. An LTV above 120% is generally viewed negatively, which means if you are buying a car with a current market value of $17,000, the amount of the loan will be $20,400 or less ($17,000 X 1.2). 

When making this calculation, lenders will often not include the price of an extended warranty or GAP insurance because lenders understand that these products can protect their risk of a large repair bill impacting your ability to make the monthly payment, and for GAP, if you get into an accident and the vehicle is totalled, that there is enough insurance to pay off the loan.

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How Lenders Approach This:

• Higher Down Payment Requirements: Lenders will often require a larger down payment from borrowers with limited or imperfect credit. This demonstrates a greater financial stake in the vehicle and reduces the amount they stand to lose if you default.
• Focus on Affordable Vehicles: Lenders might be more willing to finance less expensive vehicles, as the potential loss in case of default is lower.
• Avoiding Negative Equity: They will be cautious about financing vehicles where the loan amount significantly exceeds the car’s value (potentially leading to negative equity, where you owe more than the car is worth).
• Used Car Considerations: For used cars, lenders will pay close attention to the vehicle’s age, mileage, and condition, as these factors affect its value and potential for depreciation.

Navigating the Process as a Middle-Income Buyer with Credit Challenges:

• Be Realistic About Your Budget: Don’t overextend yourself with a car payment that will strain your finances. Choose a vehicle you can comfortably afford. Generally, the price of the vehicle should be 4.5 times your monthly gross income, so if your monthly income is $4,600, you should be searching for cars with a sales price up to $20,000. 
• Save for a Significant Down Payment: This is one of the most impactful steps you can take to improve your chances of approval and secure better terms.
• Shop Around for Lenders: Don’t settle for the first offer you receive. Compare rates and terms from multiple lenders, including credit unions, which may be more willing to work with individuals in your situation. Other options that have multiple lenders are myautoloan.com and lendingtree.com/auto. 
• Focus on Less Risky Vehicles: While its a good thing to keep the payment within your budget, be aware that you’re not buying a vehicle with too many miles that could mean repair bills are likely. While cars are lasting longer, not all cars are made the same. A Toyota with 100,000 miles is less likely to have significant repairs than a Nissan with the same mileage. Also, a compact car or mid size SUV is less risk than a sports car. 
• Can you Wait? If you don’t need to purchase a car now, think about a 90 day plan to improve your ability to have a better outcome. Use the time to manage your spending knowing tender may require your last 3 bank statements, save 10% of your gross income for 3 months and get a feel for what the car payment will be while increasing the amount of your down payment, and search for vehicles that are 4.5 times your monthly gross income and get to know which cars are more appealing than others. 

Securing an auto loan with a good outcome as a middle-income buyer with limited or imperfect credit requires patience, preparation, and a realistic approach. By understanding how lenders assess your application and focusing on factors you can influence, you can increase your chances of getting behind the wheel of a vehicle that meets your needs and budget. Remember that building or rebuilding credit takes time, so every positive financial step you take will contribute to a brighter financial future.