FICO Score and Your Auto Loan
It's time for a new car. Whether you are yearning for that brand-new-car-smell or you are browsing certified, you are probably looking at the sticker prices and thinking, when did cars get so expensive?
Understanding How Your Credit Score Will Affect Your Car Loan
Car prices have risen 29% in the last decade. One reason is the rise of advanced technologies in auto manufacture, improving driver interface, fuel efficiency, and safety. Another reason is the increase in subprime lending and default on car loans. These costs are passed on to you, the responsible consumer who just wants to finance a new car and make monthly payments.
Your monthly car loan payments are based upon the cost of the vehicle, of course, and are also largely dependent upon your credit score, which affects the interest rate a lender will offer you.
What is a FICO Score?
A FICO score, or credit score, is a three-digit number that represents the amount of risk you post as a borrower. The higher the score, the lower the risk of default on a loan.
The information that informs your credit rating includes whether you have made monthly mortgage or car payments in full and on time, whether you are in arrears or have defaulted on any accounts, whether your revolving credit accounts are current, how long your credit history is, and whether or not you have filed bankruptcy.
How Auto Lending Works
Auto lenders categorize borrowers into categories according to their FICO score. While the exact number ranges may vary somewhat according to which credit agency the lenders use, here is an example:
- Superprime: 781-850
- Prime: 661-780
- Nonprime: 601-660
- Subprime: 501-600
- Deep Subprime: 300-500
A lender will offer a Superprime borrower the lowest interest rate and the best terms because lenders perceive that that borrower poses a very low risk of default. In contrast, a Nonprime or Subprime borrower can still get a loan, but lenders will offer that borrower a "subprime" loan with a higher interest rate and perhaps heavier penalties for paying late or defaulting.
Car Loan Cost Comparison - a Tale of Two Similar FICO Scores
This example provides rough estimates based on currently-available interest rates. It cannot take into consideration what taxes and fees would be imposed upon your car purchase in your state.
Julie has a Prime credit rating of 670. She is interested in a new car that costs $25,000. She puts $5,000 down and finances $20,000 over 60 months or five years at 4.5% interest. She will pay about $375 a month, paying about $22,400 in total. $2400 of that is interest.
Sarah has a Nonprime credit rating of 640, not that much lower than Julie's score. She wants to buy the very same type of car as Julie. She too puts down $5,000 and finances $20,000 over 60 months/five years. In contrast to Julie, Sarah will pay about $410 a month and $24,200 in total. $4200 of this is interest.
While it might seem outrageous that one borrower must pay $1800 more than another when there is only 30 points difference in credit score, this is how it works. The take-away is, improving your credit score by 30 points can save you $1800.
Easy Ways to Improve Your Credit Score
It is not difficult to raise your credit score by the 30 points that just cost Sarah $1800. Even if you can't raise your score enough to fall into the next category of borrowers, know that whatever you do to improve your credit will reflect favorably upon you in the eyes of potential lenders. Financially-responsible behavior now will eventually crowd out old events that damaged your credit score over time.
You can start to rehabilitate a poor credit history by taking the following actions:
- Check your credit reports for errors and inclusion of accounts that do not belong to you. Go to the credit agency's website to dispute whatever information does not belong.
- Keep old revolving accounts open even if you don't need them and they have a $0 balance. This shows you have credit and don't need to use it.
- Do not open several new accounts at once. This is perceived as desperation for credit.
- Pay down some debt to improve your debt-to-income ratio.
- Keep accounts current. Pay mortgage or rent and utilities in full and on time.
Most importantly, be patient. Black marks on your credit history eventually fall off the report after seven years. Also, lenders always look at the most recent credit behavior, and if you can show you are making an effort to improve your credit rating, that may prompt a lender to offer you a more favorable interest rate. Good luck!
About the author:
Veronica Baxter is a legal assistant and blogger living and working in the great city of Philadelphia. She frequently works with David Offen, Esq., a busy Philadelphia bankruptcy lawyer.