Your Credit Score and Your Car Loan
If you are worried about your low credit score and if you are eligible to get a car or car financing from auto lenders, don't worry since there are different options to consider.
I previously had bad credit, so I know how you feel. To experience the sticker shock of the insanely high-interest rate can really let you down, but there is hope.
I am not a financial expert, but I will share my personal experience.
However, I will help you understand what impacts your credit score and how you might improve it. (Side note: I got from a 680 to over 780 in a few years.)
Having decent and good credit is crucial to accessing the best rates. Your credit score is a key factor in your interest rate for an auto loan. It showcases your fiscal responsibility as well as how you manage debt.
Low credit will make it hard to get approved, or if you do, you will be shocked at the high rates from dealers.
To help alleviate any apprehension by banks, lenders may request you to put down a bigger down payment.
My # 1 Rule for financing your next vehicle is to be responsible with your finances.
This golden rule will help you 10x fold in your life, and I guarantee you will be happier and in a better place if you do.
Let's dive in on the factor that affects your FICO and credit scores so you can tackle it head-on.
Factors that Affect Credit Scores
To understand how credit scores can impact auto loan approvals, we will review the factors that makeup credit scoring models.
Carrying large debt is not good for your credit score.
If you have $3,000 in savings but $5,000 in debt as a credit card balance, you would be better off paying off that $5,000 as quickly as possible since you will be making back the interest on that amount.
If your APR is 18%, for example, consider getting 18% back on your money.
Is it easy to do? No, and it will be dreadfully painful. But…
I know. I know. You might be saying that you need an emergency fund and you need to have a cushion for a rainy day.
I would try to offset your debt using some of your savings. Reducing your debt is the best way to improve your credit score and credit mix.
Your credit utilization ratio should be considered - too much of it is not a good sign!
You can opt to use your credit card in an emergency as you free up your available credit. BUT DO NOT ADD to your debt if you can avoid it.
The second tip is to have a good payment history. Make all your payments for at most 60 days since they will be reported as missing. How long you have credit history and inquiries concerning new credit can also impact your credit score.
Your amount of debt and payment history make up the bulk of your credit history.
I'll cover the importance of a consistent payment history.
Your Payment History Matters
Your payment record is a key factor and a major consideration when determining a credit score from credit bureaus. A spotless record for a period of time demonstrates your ability and habits to pay debts on time. Your credit mix can include student loans, credit card debt, personal loans and a home mortgage.
You might assume that missing a payment doesn't matter, but it is crucial to measure your creditworthiness.
Let's look at how making payments on time will factor in.
Payment History Factors
Actual Data Reviewed
30 days or more delinquent
Unpaid accounts from Collection Agency
Records of Individual filing of bankruptcy
It's worth mentioning that late payments have varying effects on your credit score. This depends on when they happened, how often, and the balance.
Negative marks are sent at 60-day and 90-day lateness.
Going to a collection agency is not good news either. However, it would help if you took action to help resolve your outstanding balance to get your accounts up to date.
If you are trying to improve your scores, give yourself 3-6 months of on-time payments and paying down debt to improve your scores.
Are You Considering Bankruptcy?
If you are really in the hole, then you might consider Bankruptcy.
However, I would only suggest that you go down that route if you are emotionally and mentally ready to be tarnished for seven years.
Financial experts will advise that Bankruptcy records stay on file for seven years, greatly reducing an individual's credit score. It will "damage" your credit score and make it extremely difficult to obtain loans in the future.
However, the positive note is that the collection agencies will stop contacting.
Financial expert, Dave Ramsey, advises avoiding Bankruptcy at all costs. He went through it himself and shared his advice in the 6 Steps to Avoid Bankruptcy article.
Debt and Your Credit Utilization Ratio
One factor that affects credit scores is the 'credit usage ratio.' This is how much of your available credit you're using. Keeping it under 30% is ideal. If you can keep it under 10%, that would be best.
Having a high ratio will lower your score because it translates to more risk to lenders regarding your ability to repay the loan.
As I mentioned, you can improve your credit scores by reducing your balances.
While you might be tempted to increase your available balance or open a new credit card to increase your available credit, your FICO score will decrease in the short term.
I would only do this if there was a promotional rate or offer that you wanted to take advantage of.
A long and consistent credit history will provide Experian and TransUnion with the data to improve your credit score.
New Credit and Credit Inquiries
Applying for new credit can affect your credit score. Here are four points to consider:
- Hard inquiries will lower your score. (Avoid single inquiry or credit checks until ready to buy a vehicle)
- Soft questions, like pre-approvals, don't affect your score.
- Be strategic when applying for new credit to avoid hurting your score.
For example, my friend once applied for many loans quickly, not knowing it would harm her credit score. Her score suffered, making it harder to get approved later. She learned her lesson and became more careful with money and credit applications.
Bottom line: Ignoring credit can offer short-term relief, yet it's bad for your financial health in the long run.
Impact of Credit Scores on Auto Loan Approval
You might be wondering how to check your credit score. I have two favorite websites that I have used and continue to use today. They are CreditKarma and FreeCredit Report.com
CreditKarma is very easy to use and is my go-to site. It's simple to sign up, and it's free. They have offers, but I mainly use them to check my credit score. CreditKarma also provides email updates if there is anything weird or odd on your account.
I also use FreeCredit Report.com. As the name implies, it's free too. They are a legit site and are now an Experian company. You can see your report and get copies for your records.
What Rates You Can Expect Based on Credit Score
Depending on your credit score, you can qualify for specific interest rates. Here are the following tier categories from Experian's Auto Finance Report Q4 2022:
New Car APR
Used Car APR
781 - 850
661 - 780
601 - 660
501 - 600
300 - 500
Standard Auto Loan Requirements
To get an auto loan, a good credit score is a must! Here's what lenders look at:
- Credit Score: A credit score above 660 (Prime Tier) will increase the chances of auto loan approval.
- Income Stability: Showing steady income proves you can make timely payments and have a solid payment history. It's better to have been at the current job for two years or more.
- Debt-to-Income Ratio: Lenders check how much of your monthly income goes towards debt payments to see if you can afford the loan.
Subprime auto loans aren't just for people with bad credit. They can be for cars with bad karma too!
Do You Have Bad Credit?
Subprime Auto Loans and Bad Credit Auto Loans
Lenders offer subprime and bad credit auto loans to help individuals buy a vehicle. These loans usually come with high-interest rates, tough requirements, and shorter payment terms than regular auto loans. It can take a lot of work to get approved for an auto loan with a low credit score.
Check out the comparison below of Bad Credit Loan options:
Min. Credit Score
550 - 620
11% - 18%
4 years or less
14% - 21%
3 years or less
If you have a low credit score, you can increase your chances of being approved for an auto loan and potentially lower your interest rate by:
- Improving your credit score before applying.
- Saving up for a down payment or trade-in value to reduce the total amount financed.
- Considering working with a co-signer who has good credit.
Follow these tips and get ready to drive off with a new car.
Final Thoughts: Aim to Improve Your Credit Score for Auto Loans
Increasing and maintaining a good credit score is key to getting auto loans. This has several benefits: better interest rates, lower credit utilization, and less pressure on monthly payments since you would be carrying less debt.
Compounding monthly payments on your credit card and other debt is debilitating. While you can get an auto loan with less-than-ideal credit, you are slightly disadvantaged because of the high-interest rate.
In addition, poor credit scores may put you at risk of getting rejected for the loan.
Keeping a prime and super prime credit score should be your goal to increase your chances of getting approved. Follow the simple tips to pay bills on time, reduce debt, and watch your credit report.
By doing these things, you improve your financial health and benefit from the opportunities that come with it.
Frequently Asked Questions
1. What is a good credit score? How does it affect my auto loan?
A credit score is a numerical representation of a person's creditworthiness. Lenders use credit scores to determine the likelihood of repayment on the loan on time. Your credit score affects your interest rate and the terms of your loan.
2. What can I do to improve my credit score before applying for an auto loan?
You can improve your credit score by paying your bills on time, reducing your debt-to-income ratio, and being patient with the time it takes to update your score. It may take some time to see an improvement in your score, so be patient.
3. Can I get an auto loan with a low credit score?
Yes, you may still be able to get an auto loan with a low credit score, but you will face higher interest rates and less favorable terms.
4. What is a good credit score to have?
A good credit score for an auto loan typically falls between 700-749 or higher. However, some lenders may still consider borrowers with lower scores, and it ultimately depends on the lender's specific requirements.
5. Will my credit score be impacted if I am approved or denied for an auto loan?
If you are approved for an auto loan, your credit score may initially decrease due to the hard inquiry on your credit report. However, making on-time payments can ultimately improve your score. Your credit score will not be directly impacted if you are denied an auto loan.
6. If I refinance my auto loan will it improve my credit score?
Yes, refinancing your auto loan may be an option to improve your credit score if you can secure a lower interest rate and make on-time payments. However, evaluating the costs associated with refinancing is important, such as application fees and prepayment penalties.