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Having a good credit score is one of the most important aspects of purchasing a car. While there’s no set minimum in order to buy a vehicle, a score on the lower end could raise how much you’ll have to pay and could make you jump through a few extra hoops. Adhering to credit score best practices outlined below could help make you a more attractive applicant.
How Does My Credit Score Affect My Car Loan?
Your credit score determines your creditworthiness to lenders and those you are trying to buy something from. When applying for a car loan, your credit score helps determine if you’ll qualify for certain loans and interest rates. Borrowers with higher tier scores like prime and super-prime will get the best rates.
According to Experian, the average credit score for new and used vehicles is climbing, with the average score being 732 in the second quarter of 2021. The average score for a used car loan was 665 in that same time frame. With the rise of higher scores, it’s more important than ever to work on your own score if you want to get fair loan terms.
Different lenders may use a variety of scores when viewing your application so it’s best to practice smart borrowing habits no matter the type of loan you have.
Is There a Minimum Credit Score to Buy a Car?
Credit scores are usually grouped into categories based on number ranges. While there’s no minimum score requirement per se, the higher your score, the better borrower you are in the eyes of lenders. Experian, one of the three credit bureaus, breaks up credit score ranges like this:
- Super prime (excellent credit): 781-850
- Prime: 661-780
- Near prime (also sometimes called non-prime): 601-660
- Subprime (501-600)
- Deep subprime (300-500)
Nearly 54% of used car loans are issued to prime borrowers, who have good credit, or super-prime borrowers, who have near-perfect credit, demonstrating how important it is to have good credit. Those borrowers will get a better interest rate. While those with a lower credit score can still receive a car loan, their auto loan rates will be much higher. In particular, subprime borrowers will often pay more than three times the interest rate that a super-prime borrower pays.
Used Car Loan: Average Loan Rate by Risk:
- Super Prime 3.66%
- Prime 5.49%
- Near prime 10.49%
- Subprime 17.11%
- Deep subprime 20.58%
New Car Loan: Average Loan Rate by Risk:
- Super Prime 2.34%
- Prime 3.48%
- Near prime 6.61%
- Subprime 11.03%
- Deep subprime 14.59%
Adding it All Up
For example, three borrowers took out a loan for the same new vehicle at $37,000 over 48 months. The prime borrower qualifies for a rate of 3.48%, the near-prime borrower qualifies for a rate of 6.61%, and the deep subprime borrower has a rate of 14.59%.
The prime borrower will make a monthly payment of $826.84, paying a total of $2,688.46 in interest. The near-prime borrower’s monthly payment would be $879.33, paying $5,207.92 in total interest. While the deep subprime borrower’s monthly payment would be $1,022.06, with that borrower paying a whopping $12,059.09 in interest across the length of the loan.
In this scenario, the deep subprime borrower will pay $9370.63 more in interest than the prime borrower for the exact same vehicle. This is another example of why having a good credit score can help you out in the long run with better financing options. If this deep subprime borrower could bump up their score to at least subprime (not to mention near-prime or higher), they could save thousands of dollars.
Buying a car with less-than-perfect credit can be challenging. Here are a few extra tips:
Why Are Used Cars Suddenly So Expensive?
Now is a very bad time to buy a car, especially if your credit score is low. While May’s Consumer Price Index showed that prices were up 5% overall from a year earlier, about ⅓ of that increase was due to the price of used cars. Used car prices rose 30% in the 12 months leading up to May.
According to Edmunds, the average used car price hit $26,500 in June, up 27% from a year ago, while the average new car transaction price is $41,000, up 5%, virtually the same as the average sticker price of $41,500.
What’s Causing This?
The world supply chain is still in a rut, causing problems across many industries and countries. There is a worldwide shortage of microchips, which affects anything from new cars to laptops and vacuums. The COVID-19 Pandemic has thrown a wrench in the world’s fragile ecosystem of moving goods. Factories and ports throughout Asia and the world had to suspend operations, leading to a depleted backlog of items.
Combine this with the fact that people are shopping at historically high levels, and it makes sense why there are shortages. Many individuals weren’t able to spend their money on travel or entertainment over the past two years, leading them to purchase goods instead. People who benefitted from stimulus checks also had more money in their pockets to spend.
With demand high and supply low, prices on everything rose. This has led people to look at used cars more as a way to save money on such a big purchase.
What Salespeople and Their Lenders Don’t Want You to Know
Car dealers and lenders couldn’t be happier about these events, as it means they can sell their products at a markup without fear of customers going elsewhere. With so few options available, car dealers know they have the advantage over the consumer.
Demand Gives Car Sellers the Upper Hand
With high demand and low supply, car dealers hold more control over prices and loan rates. Simply put, if you want a car right now, you’re going to have to pay more for it no matter where you shop. With the world supply chain still stretched thin and demand remaining high, this trend is likely to continue into 2022.
They Want Your Business — But Only on Their Terms
With the power dealers have right now, they’ve been more selective than ever about which customers they work with. For example, there are some dealers who will turn you away unless you agree to use their financing and pay their rates when you make a car purchase.
For borrowers who are able to secure better rates from a bank or credit union, this practice is especially bad. Even an extra $15 a month could cost you more than $1000 over the course of the loan payments.
Which Credit Scores Are Used?
Lenders can choose which credit scores they want to look at when evaluating a car loan application. Depending on the lender, they may use a different score or even a combination of several credit scores. This makes it hard to determine which scores the lender will see when they look over your application.
FICO Auto Score and VantageScore are the two main credit ratings used in the automotive finance market, with many similarities between the two. Both scoring systems will look at one of your credit reports from the three major credit bureaus —Experian, Equifax, or TransUnion. FICO specifically has a score for auto lenders ranging from 250 to 900. While these scores are created specifically for auto lenders, they are based on generic FICO scores but are slightly altered to predict the borrower’s likelihood of repaying a car loan. This makes your history with auto loans especially important. Lenders may also just look at the more traditional FICO Score 8 and 9 to gauge your creditworthiness.
VantageScore 3.0 and 4.0 are credit scoring models created in collaboration with Experian, Equifax, and TransUnion. Between the two scores, there are minor differences, as they all evaluate similar factors, including on-time payments, number of accounts, and credit utilization.
To check your credit score, visit Annual Credit Report for an official, free version of your rating. Credit card issuers and Experian also offer options to view your credit score for free.
The main factors that determine your credit score are:
- Payment history: This is mostly just to determine how many payments you’ve missed (if any) over a certain period.
- Credit utilization: This factor looks at what percentage of your credit line you used every month. Generally it’s good to use 30% or less.
- Age of accounts: If you have a lack of loan history, lenders may be apprehensive to trust you’ll pay back your loan. All you can do in that case is build healthy, multi-year accounts to boost your credit standing.
- Account mix: This is just looking at which types of loans you have — credit cards, mortgages, car loans. Some diversity can be considered a benefit, as long as you have on-time payments with each.
- Inquiries: These are checks on your credit score, which typically only happen when taking out loans for things like a car or house. Hard inquiries will slightly decrease your score while soft checks (like your visiting Annual Credit Report) won’t affect it.
How Can I Boost My Chances of Approval?
There are many ways to improve the chances of getting approved for a car. Depending on which category you fall into, follow these tips:
If You Need to Buy Now
- If at all possible, try to secure your financing before you start to shop (credit unions are a good place to start).
- Be willing to pay a higher interest rate.
- Get a family member to help you out by acting as a co-signer on your loan application, especially if they have a better credit score than you.
- Expand your shopping search. Try to look for individual sellers in your area instead of dealerships. Prices are usually more favorable. If you try to buy from an individual, run the VIN through CarFax. This can give details on the vehicle’s accident history, prior ownership, mileage and other details. See if the car is still covered by a warranty. If not, ask if you can have a mechanic look over the car before you buy. And always take a friend if you’re going to a stranger’s house, or ask to meet the seller in a public place so you can check out the car — which also shows that it’s drivable.
- You can also visit a dealer who specializes in bad credit: Some companies will loan to you and use the vehicle as collateral. Bear in mind that if you default on payments, the car will be repossessed, with no way to regain the substantial downpayment you had to provide.
If You Have Some Time Before You Need to Buy
If you aren’t in the market for a new car immediately, now is the time to get your finances and credit in order. Consider:
- Working on your credit scores: Making on time payments is the best way to boost your credit rating.
- Establish a budget: Creating a set budget for purchases on groceries and entertainment can help you save up for that new car.
- Continue to pay down existing debt: Not only will this help your credit score, but it will decrease the impact of your future car loan.
- Don’t apply for new credit: Applying for new credit could bring your credit score down, so avoid doing so until after you’ve purchased the vehicle.
- Don’t exceed your credit limit: Avoid doing so to maintain or increase your credit score. Generally aim to use 30% or less of your credit limit if possible.
Estimate Your Car-Buying Budget
One of the biggest things you can do in preparation for buying a car is to determine your price range. Find out what you can afford, what interest rates you will get, and how much you have to pay for a down payment, if at all. Remember, a car costs more than just the initial purchase. Keep in mind gas and regular maintenance payments when factoring in your budget.
Identify the vehicles that fit your price range in addition to other factors (vehicle make, seating, gas mileage). Check out cars on Carvana, Cars.com, Auto Trader, and other sites to find the right car for you. You can also visit Consumer Reports for car ratings.
Narrow down your list and keep it handy when you apply for your loan as many lenders want to know what kind of vehicle you plan to buy. To shop for loans, check with credit unions, banks and online for car loans. Credit unions in particular have a multitude of benefits. They usually have lower interest rates, fewer loan requirements and will be more willing to work with you if you have a poor credit score. Credit unions typically require a small fee to join, sometimes as little as $5, and you usually can get a same-day loan.
If you set up a meeting in person to get a loan make sure you bring:
- Your driver’s license
- Recent pay stub
- Utility or credit card bill
- Your estimated budget
- Your vehicle shopping list
This will ensure that you can get the process completed all at once.
Don’t Forget Other Expenses
When you budget for a monthly car payment, you’ll also need to keep in mind what kind of gasoline mileage the new vehicle gets, and whether your car insurance premiums will increase. Some insurers charge more for coverage if you have bad credit, though this is illegal in some states. The main thing to remember is that a lot goes into purchasing a car, and you should only commit to it once you’ve evaluated all the factors.
The Bottom Line
Buying a vehicle is no simple feat. In the current market, even purchasing a used vehicle can come with a hefty price tag. For customers with a less than stellar credit score, buying a car can cost you thousands of extra dollars simply due to the interest rate and terms you qualify for. If possible, do what you can to boost your score before getting an auto loan. While there is no set limit that prohibits you from getting a car loan with a low credit score, lenders may offer unfavorable terms when you come to the table.