Buying a car is a major purchase. And if you're like the majority of buyers in the United States, you might not have the budget to pay the full price of your new car in cash.
That's where an auto loan comes in, allowing you to divide the cost of your vehicle into monthly (or biweekly) payments over several years.
When you apply for a loan through your car dealership or financial institution, the lender often refers to your credit score to determine how much of a risk you represent.
In this article, we'll discuss what makes a good credit score, how your score affects the terms of your auto loan, the minimum score to buy a car, and what you can do to get a loan with bad credit.
Defining a good credit score
Your credit score is, in essence, a snapshot of your credit history.
Fair Isaac Corporation (FICO) and VantageScore use the information on your credit reports to create a number that banks, credit unions, and dealerships use to determine your credit habits and risk level. The higher your score on a range of 300-850, the less risk you represent to potential lenders.
How your credit score is calculated
Several factors go into calculating your credit score. Although each company’s credit scoring models are proprietary, the following breakdown can give you a rough idea of how much each part of your credit history counts toward your credit score:
- Payment history (35%)
- Credit utilization (30%)
- Length of credit history (15%)
- New credit (10%)
- Credit mix (10%)
How to improve your score
Here are the easiest ways to build up your credit score:
Pay your bills on time
Your payment history counts for 35% of your score, so paying off your credit cards and lines of credit in full and on time is the most important thing you can do to improve your score.
Don’t use more than 30% of your available credit
Your credit utilization is the amount of available credit you use and is the second most important factor for your score. A utilization ratio of more than 50% signals to lenders that you might have difficulty paying off loans, so pay off your debts quickly and don't overspend to help keep your usage below 30%.
Keep your old credit cards active
Even if you don't often use one of your credit cards anymore, keeping the account open helps increase the length of your credit history. It also boosts your overall available credit, thereby helping keep your credit utilization ratio low.
How your credit score affects your auto loan
In general, the higher your credit score, the better interest rates you’ll get on your loan. That means you’ll pay less over the full term of the loan. You'll also pay less for car insurance.
The FICO auto score
While most lenders use your regular FICO or VantageScore credit score, many auto lenders use a special FICO automotive score to calculate your auto loan rate instead.
Unlike your other scores, FICO auto scores range 250-900 and give more weight to past car-loan payments, repossessions, and auto-loan bankruptcies than the traditional FICO score.
Categories of auto loan borrowers
Even when they don’t use the FICO auto score, car loan issuers divide potential borrowers into “prime” categories based on their credit score. Here’s how that breaks down:
Minimum credit score needed to buy a car
For the most part, lenders prefer borrowers with an average credit score in the prime range (661-780) or better. But you can often get a loan with lower scores that charge higher interest rates.
Average interest rates + terms per credit score
Here’s how your credit score influences the average APR rate and loan term you’re likely to receive from an auto loan issuer.
New car purchases
Source: Experian State of the Automotive Finance Market – Q1 2017
Used car purchases
Source: Experian State of the Automotive Finance Market – Q1 2017
Getting a loan with bad credit
If you have a bad credit score and don’t have time to improve it before applying for a car loan, there are still ways for you to get a new set of wheels.
Some lenders specialize in providing car financing options to subprime borrowers. But keep in mind that you'll pay much higher interest and that if you default on your loan, not only will your credit score suffer more, you'll also run the risk of having your car repossessed.
If you plan on trying to apply for a car loan with a lower credit score, here are a few ways you can prepare:
Make a larger down payment
The bigger the down payment you make on your purchase, the smaller the total loan amount, and the easier it will be to get approved since the lender assumes less risk. You'll also get better interest rates and lower monthly payments.
Bring documents showing financial stability
Sometimes a bad credit score can stick around for a while even after your financial situation has improved. If you feel that your credit score doesn’t reflect your current finances, bringing documentation like pay stubs, tax returns, or proof of address can help show auto lenders that you’re reliable.
Get a co-signer
Getting a co-signer with good credit to take on partial responsibility for your loan can also help you qualify and get better interest rates. Cosigners help limit the risk a lender takes by promising to cover your car payments if you’re unable to.
The bottom line
Getting a car loan can be a great way to get on the road without having to pay the full cost of your vehicle upfront. To get the best rates, try to build up your credit score before applying for financing. You should also shop around and compare quotes before settling on the best deal.
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