Everyone knows that cars are expensive but rarely do people know how their credit score affects the final price they pay. Affording a new ride often requires us to find financing, usually through a lender in the form of an auto loan. The interest rate attached to the loan could cost you thousands of dollars extra. What determines your interest rate? Your credit score.
What’s a Credit Score?
Your credit score is a three-digit number that gives lenders an estimate as to your ability to manage your credit. Three consumer credit reporting bureaus — Equifax, Experian and TransUnion — provide the information that ultimately generates your score. While FICO isn’t the only score tabulated, it comes up commonly in “credit score” discussions, because it’s one of the most common scores out there, and used by the majority of major lenders in the United States. Every consumer has a FICO score that falls within the range of 300 and 850. Your credit score comes up in the lending equation because that’s what lenders use when determining whether or not to loan you money (in the form of a loan, credit card, or line of credit) and at what specific terms.
What Do Lenders Look for in a Credit Score?
Lenders are trying to understand the likelihood that you will be able to pay them back. They do this by performing a risk assessment based on your financial past and present, largely informed by your FICO credit score. This score is based on information from your credit report, comprised of five main components, each with a different associated weight. Investopedia breaks down these components and the level of weight each one carries:
Payment History - 35%
Nobody is excited about loaning money to someone who has demonstrated a less-than-stellar commitment to repaying his or her debts. Late payments, missed payments, mortgage default, and bankruptcy all damage this section of your credit report.
Outstanding Debt - 30%
It’s a bit of a paradox, but the less debt you have, the greater your chances of getting credit. After all, the more you owe, the less likely you are to pay it all back. Something this will be referred to as your "credit utilization score." Ideally, you want to use less than 30% of your total available credit.
Length of Credit History - 14%
A long track record of responsible credit use is good for your credit rating. The frequency with which you use your cards also plays a role. This explains why older generations typically have the best credit scores.
Account Age - 10%
Having an established credit history is good for your credit rating. Opening a bunch of new credit cards in a short amount of time is not. They will also have questions about your ability to repay the debt should you suddenly choose to max out all those cards. You also don't want to close any lines of credit right before applying for an auto loan.
Types of Credit Used - 10%
From a lender’s perspective, variety is good. Lenders want to see that their clients have experience using multiple sources of credit in reliable ways.
What is a Good Credit Score for an Auto Loan?
While lenders can prescribe to their own standards when assessing an individual’s score — for example, creditkarma.com details how a mortgage lender may consider a score of 780 to be excellent and a score of 720 as “very good,” while another might consider it high enough to receive the best auto loan rate — there are some generally accepted standards across the board. According to Experian, “higher scores represent better credit decisions and can make creditors more confident that you will repay your future debts as agreed.” For your FICO score, “a 700 or above is generally considered good. A score of 800 or above is considered to be excellent. Most credit scores fall between 600 and 750.” The average credit score in America is 657.
How Do I Find my Credit Score?
It’s a good practice to regularly check your credit score anyway. But if for whatever reason you have reservations about your score, you can always check it online for free. You can go directly to Equifax, TransUnion, or Experian to view your credit reports or utilize convenient tools like Credit Karma to instantly view your credit score (upon signing up) and what’s impacting it.
Should I Get Pre-approved for my Auto Loan?
It’s not a bad idea to get pre-approved for a car loan from a bank or credit union before even shopping at a dealership. A pre-approved offer guarantees that you have a loan to cover the cost of the car you want.
Another reason? So each car dealer you visit doesn’t have to check it too. “Credit inquiries related to auto loans made within a short time frame (usually 14 or 45 days depending on the credit score model being used) are supposed to count as a single inquiry. However, some of our readers have found their credit scores dropping after multiple car dealers sent credit inquiries for financing. This is another reason why getting pre-approved before going to the dealership is a good idea” according to blog.credit.com.
Can I Still Get an Auto Loan with Bad Credit?
Yes, credit is a major factor in getting an auto loan, but you should also keep in mind that most dealers REALLY want to sell you a car. So they’re often willing to work with you in order to do so. Nerdwallet points out that, “at the end of 2017, the average credit score for a new-car loan was 713, and 656 for a used-car loan, according to an Experian report. But nearly 20% of car loans go to borrowers with credit scores below 600, according to Experian. Almost 4% go to those with scores below 500.”
While you’ll likely be able to get an auto loan with less-than-stellar credit, it might have a pretty significant impact on the loan terms and/or rate that you receive. According to Lendingtree, “Statistics show that loan lengths are getting longer and loan balances are getting higher, which indicate that lenders are stretching out vehicle loan terms to make more buyers eligible.” So the worse your credit is, the higher the rate and longer the repayment schedule might be.
How Does My Credit Score Affect My Auto Loan Rate?
Depending on your credit score, the interest rate you receive can vary widely — in fact, the difference in interest rates on a new car loan for someone with excellent credit versus someone with very poor credit is over 11 percentage points, as explained in What Credit Score Do I Need to Buy a Car by blog.credit.com. For an example of how this translates to what you’d pay, “consider applying for a 60-month loan on a car that costs $25,000. With a 2.84% interest rate, the total cost of your car would be $26,847 with payments of $447 per month. For the same loan, at an interest rate of 13.98%, your car loan would cost you $34,887, and you’d pay $581 per month.”
When it comes to car buying, your credit score plays a major role in the type of financing that’s available to you. For people with a strong score, this works in your favor. For those with lower scores or no credit, this may pose a bit of a challenge. But don’t despair! Some lenders will take other factors into consideration when determining your loan, such as a recent history of timely payments, and there are actionable steps you can take toward improving your score.
The good news is that a properly managed auto loan (where you make timely payments) can improve your credit score moving forward. So once you secure an auto loan, you can work toward strengthening your credit history in the future.