A borrower’s credit score can greatly affect the interest rate they’ll get for a car loan. Generally, lenders consider shoppers with subpar credit to be riskier than those with excellent credit. Therefore, they may charge higher rates to cover the anticipated risk. Consumers with very low credit scores may be denied a loan altogether.
What Is a Credit Score?
Auto lenders evaluate an applicant’s creditworthiness based largely on his or her “FICO” score. Created and curated by the Fair Isaac Corp, FICO says its scores are used by 90% of the nation’s top lenders. FICO scores range from a rock-bottom 300 to a maximum of 850.
According to FICO, consumers with 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 their length of credit history, credit lines recently opened, and credit mix (credit cards, retail accounts, student loans, 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.
Late or missed payments, debts that have gone to collection agencies, bankruptcies, exceeded credit limits, or outstanding tax liens all negatively affect FICO scores.
Checking Your Credit Score
Even if you’re not buying a car right now, 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 companies often provide free credit scores to their customers. Rest assured that checking your credit report regularly will not adversely impact your score.
What If You Have Bad Credit?
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% 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 credit cards, and making all payments on time.
Credit Scores and Costs
How do FICO scores affect how much you’ll pay over the long haul? Lenders use bands of scores to determine interest rates:
- 720-850: Credit scores of 720-850 can expect the best rates.
- 590-719: Expect competitive rates, but not the very best available
- 500-589: Shoppers with scores of 500-589 can face sky-high interest rates.
- 300-500: If your FICO score is lower than 500, you’ll likely have trouble obtaining a loan.
Running the numbers, this means someone with a FICO score in the 500 range may pay $10,000 more in interest over the life of a 5-year $30,000 car loan than someone with an excellent credit score.
On top of that, some auto insurance companies charge higher premiums (where allowed by state regulations) to motorists with poor credit. According to some auto insurers, this is because drivers who have low credit scores are statistically more likely to file auto insurance claims than more creditworthy policyholders.