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How do banks verify income for auto loans?

If you’re buying a car, there’s a big chance you need to get a loan for it. This process can be rather complex and has probably left you wondering, “How do banks verify income for an auto loan?”

When a bank receives your application for an auto loan, one of the first things it considers is your income. But the bank won’t just take your word for how much your income is. The financial institution uses one of a number of methods to verify that you really make the income listed on your application.

Understanding this process will help you prepare an accurate loan application and pave the way for speedy processing.

Why income matters for auto loans

In short, banks want to make sure you have the income to pay off a loan before they give you the money. This is why income verification is essential in the auto loan process. When considering an auto loan application, a bank generally looks at three factors:

  • Your credit score
  • Your proposed down payment on the vehicle
  • Your debt-to-income ratio

That last factor is where income verification becomes crucial. Your debt-to-income ratio is simply the amount of debt you carry compared to your income. Lenders want to know you have enough income to cover your existing debt and the new auto loan. This is why they’ll usually have a limit on how much total debt they will be willing to accept before extending a loan.

The maximum debt-to-income ratio that banks will accept can vary due to a number of circumstances, but for auto loans, most lenders prefer a ratio under 36%. In other words, they won’t extend a loan unless your monthly payments for any existing debt plus your payment for your new auto loan are less than 36% of your monthly income.

Banks will worry less about debt-to-income ratios if your other two factors (credit score and down payment) are particularly good. In fact, borrowers with excellent credit and a high down payment may be able to get a loan without income verification. This is because the other two factors lower the risk enough that lenders feel safe without needing to confirm your income.

How banks verify income for auto loans

We’ve examined why income is important as it pertains to auto loans. But how do banks verify income for auto loans?

The precise method lenders use to verify income for auto loans depends mostly on the source of your income. Borrowers who are traditional full-time, permanent employees are easy for banks to verify, but less traditional income sources may require a more in-depth verification approach.

Income verification of employed borrowers

If you’re a W-2 employee, banks will generally ask to see your last three months’ worth of paystubs. Some banks will bypass the paystubs by using an e-verify system to contact your employer and verify both income and employment. In the latter case, you may be able to get immediate approval on your auto loan.

Income verification of self-employed borrowers

Contractors and other self-employed borrowers will need to provide a copy of their most recent tax return. In particular, the bank wants to see your Schedule C, which sums up your income from your business.

If you’re self-employed and plan to apply for an auto loan in the next few months, consider cutting back on your claimed business expenses – even if that increases your tax bill a bit. The fewer expenses you claim, the higher your business income will be on your tax return, which can help you pass the income verification for that auto loan.

Income verification of unemployed borrowers

Some borrowers have no earned income at all. They may be retired, on unemployment, or living on a more non-traditional source of income. These are the most challenging situations for banks to verify, so if you’re in this situation, you may need to offer up more extensive documentation to the lender.

Banks will usually ask to see documents related to your income streams. For example, retirees should be ready to show copies of their Social Security statements, 1099-Rs for pensions and retirement account withdrawals, and their most recent tax return as well.

If you’re unemployed, passing the income verification will likely be quite a challenge because lenders will be concerned about what may happen if your unemployment runs out before you secure a new job. In that situation, you may need to find a co-signer with a steady income and excellent credit in order to get a loan approved.

Special concerns for the self-employed

If you’re not a W-2 employee, expect income verification to take somewhat longer. E-verification is generally not an option for self-employed income sources, so banks will have to manually verify your documents.

If you have alternative income sources, it’s a particularly good idea to get a pre-approval before you start shopping. If you wait until you’re at the dealership to apply, you may end up losing your chance to buy the vehicle of your dreams because of loan approval delays.

Some lenders will provide no-verification loans, which allow you to get a loan without any income verification. Oftentimes these loans are used by those with a lower credit score and can result in interest rates upwards of 10%. These loans generally have punitive interest rates and/or fees to compensate lenders for the increased risk of not verifying your income.

When possible, avoid these loans and stick with more traditional options, as having a higher credit score (above 700) and verifying your income can land you a loan with an interest rate below 4%.

How to speed up income verification

Ideally, you’ll have your auto loan sooner rather than later. While some things are out of your control, you can take some steps to minimize the wait to get your auto loan approved:

  • Have all your income verification documents ready to go.
  • Double-check your paystubs and other wage documents to be sure you provide accurate information about your income. If the verification turns up any discrepancies, you’ll have to start the whole process over.
  • Apply during regular business hours. Banks will be more likely to reach your employer immediately when HR personnel are in the office.
  • Make the largest down payment you can. Lenders will often skip verification entirely, resulting in a much faster approval, if a sizable down payment is made. This can vary, but 20% of the car’s purchasing price is a good benchmark.
  • Keep the loan amount small relative to your income/existing debt.

For most W-2 employees, banks verify income for auto loans quickly and smoothly. But if you have a non-traditional source of income or the bank has difficulty getting information from your employer, the entire loan application can grind to a halt.

It’s safest to get a pre-approval before you even start shopping for a vehicle so that you won’t have to wait to purchase the one you really want. If you’ve already located the vehicle you want, take the above steps to make income verification easy for lenders so that you can sail through the approval process.

Landing your auto loan

The auto loan process is long and fraught with potential hurdles. Understanding how banks verify income for auto loans will help you prepare for any potential issues and increase your chances of having a smooth loan process.

Follow the advice in this article, and you could soon be driving home in your new vehicle. If you’re planning on any other large purchases, like a home, be sure to prepare yourself for that employment and income verification process as well.

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