It’s all a numbers game when it comes to getting approved for an auto loan, and those numbers refer to a borrower’s credit score. Generally, lenders consider applicants having sub-par credit to be riskier than those having excellent credit. That means low-scoring applicants will be charged a higher interest rate and, in turn, a higher monthly payment to finance a car or truck. Consumers having the lowest credit scores may be denied a loan altogether.
What is a Credit Score?
Auto lenders evaluate an applicant’s creditworthiness based in large part on his or her “FICO” score. Created and curated by the Fair Issac Corp, FICO says its scores are used by 90 percent of the nation’s top lenders. FICO scores range from a rock-bottom 300 to a maximum 850.
According to FICO, consumers having scores in the 700-850 range are considered near-prime or prime borrowers. That means they’ll garner the lowest interest rates and most-favorable loan terms. Borrowers who fall below the 620 mark are often considered “subprime.” That means they’ll pay more to finance a car.
How are Credit Scores Determined?
FICO scores are largely based on a person’s payment history and outstanding balances. Other considerations include length of credit history, credit lines recently opened and one’s credit mix (credit cards, retail accounts, student loan, installment loans, etc.). In addition to the FICO score, a credit report will disclose all open and closed credit sources, credit inquiries/applications made and information on overdue debt, bankruptcies and civil lawsuits. Lenders will further consider an applicant’s annual income to assess how large a monthly car payment he or she can afford.
Having late or missed payments, debt collections, bankruptcies, exceeded credit limits and/or outstanding tax liens will send a FICO score plummeting.
Checking Your Credit Score
Even if you’re not buying a car just yet, it’s wise to check your credit score periodically. Federal law allows consumers to obtain one free report each year from each of the three major credit bureaus, Equifax, Experian, and TransUnion. Banks and credit card providers often provide free credit scores to its customers. Be assured that checking your credit report regularly will not adversely impact your score.
What if You Have a Poor Credit Report?
If you find an inaccuracy or mistake in your report, be sure to contact both the lender and the reporting agency to have it corrected. In a study conducted by the Federal Trade Commission, 28 percent of those participating found at least one substantive error on their credit reports.
Otherwise, you’ll want to work to improve a low credit score. Experts advise steadily paying down your existing debt, especially high interest-rate credit cards, and make all payments on time. Pay off or keep your balances minimal.
But, as FICO recommends, don’t apply for additional credit cards or close unused accounts in a misguided attempt to boost your credit score. Likewise, avoid transferring debt from one source to another. Either of these tactics could backfire and result in a lower credit score.
If you have a below-average credit score, all is not necessarily lost. Underwriting standards usually vary from one source to another. It pays to contact multiple lenders (including a credit union if you’re a member) to determine which will offer the lowest rates, given your history and current financial situation.
Credit Scores and Costs
As of this writing, FICO says those having credit scores of 720-850 can expect to pay a national average of 4.31 percent interest on a $30,000 auto loan with a 60-month term. If your score is between 690 and 719 you’ll be charged an average 5.67 percent. And it only goes up from there. Those having weak scores of 500-589 will face sky-high 16.4 percent rates. (If your FICO score is any lower, you’ll probably have trouble obtaining a loan at any cost.) Running the numbers, this means someone having a FICO score in the 500 range will pay over $10,000 more in interest over the life of a five-year $30,000 car loan than will someone having excellent credit.
On top of that, some auto insurance companies charge higher premiums (where allowed by state regulations) to motorists having poor credit. According to auto insurer State Farm, this is because drivers who have low credit scores are statistically more likely to file auto insurance claims than more creditworthy policyholders.
Editor’s note: This article was originally published in June 2015. It has been completely updated for accuracy and comprehensiveness.