Car driving with money from the bank

The auto-finance business is enormous, with hundreds of institutions making hundreds of billions of dollars’ worth of car loans every year. For many consumers, though, it can be hard to know which type of lender is right for their financial situation.

More on Buying a Car

The largest lenders are big national banks, such as Bank of America, Capital One, Chase, and Wells Fargo, but there are other choices out there. The “captive” finance companies that belong to the automakers, such as Ford Motor Credit and Toyota Financial Services, are big players. Some of the best deals come from those captives, especially when the automaker is subsidizing the loans.

Other lenders include credit unions, local banks, and online banks.

Because it can be a challenge to determine which is the right choice, we have created this list of the pros and cons of each lending institution. And after that, we discuss why it is so important to get preapproved for a car loan.

Banks

They generally have very specific, conservative loan policies, and some may cater only to those borrowers with a better credit standing. These institutions are in a position to offer some very competitive loan rates. Offerings vary tremendously, though, and some banks are more willing than others to make loans to people with marginal credit.

Because a car shopper probably has a relationship with at least one bank already, the local branch might be a good place to start. Most banks have websites that make it easy check their current loan rates, and shoppers can apply for a loan either online or at a local branch. Visiting the branch is a good way to avoid any mistakes or misunderstandings, and might result in an even better offer.

Pros

  • Have state-of-the-art digital banking platforms and security systems for shopper data
  • Can offer competitive loan rates to qualified applicants
  • Local banks have more personalized knowledge of customer

Cons

  • Often have conservative loan policies that prevent people with low credit scores from getting or even applying for a loan
  • Often have high fees on loans
A blue car driving away with a car loan

Credit Unions

These lenders operate a bit like banks, but they are usually nonprofits owned by their depositors, with lower operating costs than banks. Many credit unions lend money only to their members. However, some will make loans to people who don’t have deposit accounts with them. The website credit.com maintains links to several credit unions that will make loans to the general public.

Pros

  • Offer lower interest rates on loans and credit cards
  • Easy loan applications
  • Better, more personalized service
  • Often better represented in underserved communities

Cons

  • Many are linked to employers or a group, which limits who can become a member
  • Credit unions still have fees, albeit lower ones than banks
  • The average credit union has only three branches
  • Tend to trail banks in digital offerings

Online Lenders

This is a very convenient way to borrow money, and it's easy to find competitive rates. Sites such as Clearlane (operated by Ally Bank), E-Loan, and LendingTree farm out requests to numerous lenders and usually provide you with several competing offers. Individual lenders like Capital One, Wells Fargo, and Chase also have online loan operations.

As a precaution, check the Better Business Bureau rating for every lender that is contacted before you file an online application.

Pros

  • Can apply to many lenders at one time without it having an impact on your credit score too much
  • Offer more competitive interest rates than traditional banks

Cons

  • May be difficult to reach a person for assistance
  • Difficult to control how they share personal information
  • Could be bombarded with email and phone calls from different lenders
  • Some charge high fees and/or have loan prepayment penalties

Dealerships

Dealers typically work with their automaker's financing group, as well as banks and other sources. Shoppers with offers from some of the other sources we’ve mentioned may be able to negotiate the dealer’s initial loan quote down to something more attractive. That's why it's important to do research.

Pros

  • Convenient to use since you are already at the dealer
  • Manufacturer financing is often subsidized, so people who have good credit may qualify for very low rates
  • Dealer loans through banks are open to people who have lower credit scores

Cons

  • The interest rates for dealer loans through a bank are often marked up to give the dealer a profit
  • With dealer loans through a bank, buyers with low credit scores will pay a high annual percentage rate (APR)
  • Manufacturer-backed loan rates are available only to customers with high credit scores
  • With manufacturer financing, if both a rebate and low interest rate are offered, buyers can usually choose only one

Get Preapproved

There are many advantages to shopping around for auto loans and lining up financing before striking a deal on a car.

Loan shopping gives buyers the chance to compare interest rates. Those rates can vary a lot, regardless of credit standing. The wider the net is cast, the better the chance of landing a bargain.

Second, getting preapproved buys peace of mind. While the deal may not be the best one possible, buyers will at least know they have enough money to cover the purchase, and know the interest rate, and length of the loan.

To get preapproved, buyers must have a pretty good idea of what the new car will cost, including all taxes and fees. Deduct the down payment to determine how much the loan will have to be.

Once the lender approves the loan amount, say $25,000, he or she will give the buyer a blank check good for any amount up to that limit. The check can be returned if it turns out that a better deal is available elsewhere, such as through the dealer. There may be fees involved in returning a check, though, so read the fine print before agreeing to any deal.

Keep in mind that each time a consumer applies for new credit, it lowers his or her score a little for a limited period of time. But credit bureaus treat a cluster of auto-loan applications occurring in a short period as a single application rather than several, and the negative affect should be minor and short-lived. Loan aggregators such as E-Loan and Clearlane make this easy because they pull a person's credit score one time and use it for the various lending institutions they work with. Still, try to keep all loan applications confined to a short time period, about 30 days.