There is a great deal of confusion and misinformation about the true meaning of pre-approved versus pre-qualified automobile loans and financing offers.
Many online articles mix the two concepts together, when they actually have distinctly different processes, with unique consequences and next steps.
It boils down to who begins the process. Lenders initiate pre-approved auto loan offers, using only 1/3 of the information needed for a final decision. Consumers request that lenders pre-qualify them for car financing, using 2/3 of the information.
What happens during and afterward reveals the true definition of pre-approval versus prequalified car loans – so pay close attention if you are in the market for a new ride.
Pre-qualified Auto Financing Process
The pre-qualified auto financing process begins when you, the consumer, initiate the transaction. This means that you are in control of key steps from beginning to end – except for the underwriting decision, which the lender makes.
The lender will qualify you in advance by evaluating 2/3 of the final criteria: your consumer report and income. You will quickly know the sticker price you can afford to buy or lease. Walk confidently to the dealership with a voucher. Manage the remaining 1/3 of the criteria properly, and drive away.
Pre-qualifying for an auto loan when you have bad credit requires that you compensate by performing well on the other 2/3 of the underwriting criteria.
- Credit score
- Debt-to-income ratio (DTI)
- Loan-to-value ratio (LTV)
People with a bad credit history will have a low score. Therefore, the subprime lender will pre-qualify you for a specific amount, repayment term, and interest rate combination that keeps your DTI ratio in a safe range. You calculate the ratio by dividing the monthly payment by your monthly income. The lender will want to keep DTI below 15%.
Repairing your existing car is most realistic!
Having a co-signer can raise the denominator
When you are at the car dealership and ready to complete the transaction, the LTV then becomes important. People with bad credit should keep the LTV as low as possible, or risk losing the deal.
This is the final 1/3 of the criteria, which only you control. Nobody knows the collateral value until you decide which car you want to buy. Lenders can only guess at the blue book value of your trade-in until the dealer inspects the vehicle.
The best way to keep LTV low is to make a large down payment!
Buying an affordable vehicle is another option
Online or In Person
Many people ask about the pros and cons of pre-qualifying for a car loan online or in-person. This seemingly insignificant distinction can make a meaningful difference. Choose the option that works out best for your situation.
The advantage of getting pre-qualified for an auto loan online is these automated systems utilize a soft pull. The lender never sees any information from your consumer report. The bureau performs all the calculations on their servers. The process is fast and convenient.
Soft pulls do not affect ratings.
The disadvantage of using an online system is that they work with income estimates that you input into the web form. If you later fail to provide adequate documentation to back up the numbers, the approval could fall through.
The drawback to being pre-qualified for a car loan in person is a hard inquiry. The bank or credit union may evaluate your consumer report, which means that the bureau will log a hard inquiry. However, this may not be a big concern if you move quickly.
The benefits of working in person at the bank or credit union are the personal service, and a stronger recommendation. Many consumers prefer working face-to-face with a real human being. The banker can collect all your employment and income paperwork in advance, which leads to fewer surprises at closing.
Pre-Approved Car Loan Process
The pre-approved car loan process begins when a lender decides to send you a letter in the mail without your explicit consent or foreknowledge. In this case, the lender initiates the transaction. The potential borrower is passive up until the point her or she reaches into the mailbox and opens the offer.
The consumer determines what happens after this point. His or her actions dictate what might then appear on their consumer report and whether the lender approves the financing.
Letters in the Mail
Banks frequently send pre-approved car loan offers in the mail to consumers who meet specific predefined criteria, based on information found only on their consumer report. They do so proactively. The Fair Credit Reporting Act makes this process legal but stipulates that the lender must make a firm offer of credit in exchange for a modest invasion of privacy.
Since the lender decides who receives the pre-approved offer, the bureau supplying the information logs a soft or promotional inquiry on your file. Soft inquiries do not affect your rating because they do not represent your behavior – they denote the bank’s decision to review your borrowing and payment history.
When the pre-approved car loan offer arrives in your mailbox, the lender only has one of three critical components needed to make a final decision – yet they still must make a firm offer of credit – unless something deteriorates.
- Credit report and score – Yes, but they can decline your application if something material changes between the prescreen and application dates.
- Debt-to-income ratio – No, income is not part of your consumer report.
- Loan-to-value ratio – No, the price of the automobile, down payment or trade-in value are yet to be determined.
What Happens After
You the consumer are in control of what happens after getting a pre-approved auto financing offer. Having the letter means that you met one of the three key underwriting criteria about three weeks before. You need to meet all three criteria when you close on the loan. Then you can drive away from the dealer in your new ride.
Toss in Trash
If you throw the letter into the trash, nothing further happens – unless an identity thief roots through your dumpster steals your personal information, and borrows money in your name. Shred the letter for extra safety.
Opt out of future prescreens if you are uncomfortable receiving mailings in the future.
Accept the Offer
If you decide to take advantage of the offer, be prepared for what happens next. The lender must make you a firm offer if you continue to meet the first criteria. Your standing on the other two factors determines the price of the car you can finance.
Expect the lender to perform three activities before reaching its underwriting decision. At this point, they will have completed 3/3 of the evaluation process.
- Pull a hard inquiry report to verify that you still meet the credit criteria. If not they can legally decline the application. Hard inquiries affect your rating.
- Request an income and employment verification to confirm that the monthly payments divided by monthly income do not exceed a set ratio.
- Calculate the loan-to-value (LTV) ratio by subtracting your down payment and/or trade-in value from the retail dealer sticker price of the vehicle.
If you pass the first requirement, the lender must approve your loan request – but not for any amount. A car loan pre-approval does not allow every recipient to drive off in a Lamborghini or Porsche. Your DTI and LTV must fit within accepted parameters. It is not a blank check where you just fill in any amount.