One of the fundamental rules of negotiating the price of a car is to never find yourself negotiating more than one deal at a time. If you are haggling over the price, do not involve financing or trade-in value. Car dealerships are often the largest game of Three Card Monte in the world. The greatest value of arriving to a car lot with a pre-approved car loan is that it removes one of the cards from the dealer’s hand and gives you both negotiating power and options. There are few drawbacks to getting pre-approved, but the potential impact to your credit score is one.
Car dealerships are out to maximize the money that they receive from a transaction, and there are three ways to do it: on the sales price of the car, on the money they will make from financing the car, and on the profit they will make on a trade-in. Amazing deals on one or two of those profit centers are compensated by the other one or two. By arriving at the table with your auto loan pre-approved, you have limited the number of places that the dealership can hide a profit. For example, a dealership will gladly trim $500 from the purchase price of a car if they have cornered you into an unusually long loan term through their preferred lender, resulting in thousands of dollars of extra interest charges over the life of the loan. The pre-approve loans also gives the buyer leverage because the dealer loses one of the means by which the buyer is made to sit waiting uncomfortably while the “finance office” determines whether the dealership can loan the buyer the money.
Beyond leverage and power with respect to the dealership, a pre-approved car loan also gives the buyer flexibility. It may be that the dealership has the best finance option available. Having a finance option in mind before arriving at the lot allows a buyer to objectively evaluate the options available and pick the right loan only after comparing terms such as interest, loan repayment term, and other terms such as fees and accessibility to the lender. Flexibility in approaching a negotiation will give more power to the buyer.
Pre-approval is not always a perfect plan; there are some drawbacks. First, if you arrive pre-approved but intend to apply for credit from the dealer just to see what they can offer, this will result in two credit inquiries in a short interval. This will have a slight negative impact on your credit score. It will not be a major hit: the scoring companies know that good consumers will often shop around for the best loan deal, and a couple of inquiries for auto loans is less damaging that multiple inquiries from credit cards, car loans, and home improvement loans. A buyer also runs the risk that pre-approval will expire before the deal on the car is complete, which will require applying for another loan. Like a second application from the dealer, this will have a slight impact on a credit score, and if your lender has an application fee it might require paying the fee again.
Pre-approved car loans are a large bargaining tool to get the best deal from a car dealer. If they are used carefully, by limiting the number of times the buyer applies for a loan, they give leverage and options to the buyer, and start to narrow the number of simultaneous deals that are being negotiated at the dealership.