You need a car, but you don’t have the cash to simply buy one outright. Or, maybe you’re tired of buying Craigslist clunkers and think it’s finally time to take a step up in the world.
Whatever your reason for a new car loan, your credit score is going to greatly affect what you can afford. A better score equals a better interest rate, which in turn equals a lower monthly payment. However, if your score is low, you may not be able to afford the one you’ve had your eye on.
No one ever wants to admit it, but you might have to have a plan B for this one if your score is low.
Whichever way your story goes, we’re here to help you navigate through the nebulous world of credit scores and interest rates. By the end of it, you should be able to make an informed decision and choose the best car for you.
Find Out Your Credit Score Before Buying a Car
Your credit score is the number that is associated with ‘bad’ or ‘good’ credit and is formed by the information in your credit report.
Before you even begin looking up cars and driving to dealerships over the weekend, you need to know what your credit score is so you can know what to expect before you even speak with a sales agent. It also helps you stay on budget right from the very beginning.
Car loan rates vary greatly depending on what score you have, so before you start eyeing up $30,000 cars assuming you can afford the payments, know what credit range your FICO scores are in.
Don’t just order one of them and assume it is going to be the same as the other two. It very well may not be! In fact, one credit reporting agency may have information about you that is completely different from what the other two have. If that’s the case, verify that the information is right.
See also: How to Get a Car Loan in 6 Easy Steps
Check for Errors on Your Credit Report
It’s currently estimated that one in five Americans has an error on his or her credit report. That’s roughly 42 million people possibly suffering from bad credit who shouldn’t be.
If you do see an error, don’t delay. Begin acting immediately to get it corrected. Contact the agency by writing and dispute the error. If you can, provide any evidence to support your argument. Do not email or call. It needs to be done through writing.
After they receive your letter, they have thirty days to review your case. If they don’t do so within this time frame, the item must be removed from your credit report. You should also receive an updated copy of your report and score. By getting negative items removed, it should improve your credit score.
What is considered good and bad credit?
There is no definitive point scale where there is a clear and well-defined demarcation between credit ranges. What we’ve gathered below are simply trends in the credit industry.
What one industry considers to be a good credit score, may be considered excellent by one, but only fair by another. So take the following ranges with a grain of salt:
- Excellent Credit 750-850
- Good Credit: 700-749
- Fair Credit: 650-699
- Poor Credit: 551-649
- Bad Credit: 300-550
So now the question begs to be asked, what kind of score do car dealerships want? Here again, the answer is not quite as simple as you would probably like.
Auto lenders have access to their own FICO scoring report that predicts the likelihood that you would default on an auto loan. Not only is it separate from the other three credit bureaus, but the range is different as well (250-900).
So does this mean you shouldn’t worry about what your credit scores are on the other reports?
Absolutely not. Much of the information is repeated throughout all reports, so an error on one is likely to be an error on another.
What credit score do you need to buy a car?
There are many auto lenders who don’t have minimum credit score requirements. They work exclusively with people with poor and bad credit, and unfortunately, they are not doing so out of the goodness of their hearts.
Poor and bad credit equals higher interest rates, which equals more money in their pockets. So, no auto dealer really ‘wants’ you to have a solid credit score. A better way to ask your question would be, “What credit score do I want?” or “How much can I afford to pay each month?”
The following credit ranges are just the average credit score across the auto industry and can vary greatly dealership to dealership. Choose your dealership and lender wisely.
- Excellent Credit: 740-900
- Good Credit: 680-739
- Fair Credit: 620-679
- Poor Credit: 550-619
- Bad Credit: 549 and below
As mentioned above, auto lenders have access to a unique FICO score that only they can see. If you remember, the range goes as high 900.
Averages were taken, and people with ‘excellent’ credit generally had a score that fell between 740 and 850. The ranges for the other ratings were gathered the same way.
What are interest rates like for each credit range?
You have to separate loan rates for used cars and new cars because they vary greatly but here are some examples of what you can realistically expect:
|Credit Rating||Used Car Rate||New Car Rate|
Again, these numbers are just averages. For any credit rating you fall in, the interest rate you’re offered may vary depending on what auto dealer you go to.
What kind of monthly payments can you expect with your auto loan?
There’s no need for this to be a surprise. You can figure out your monthly payment long before you speak with a car salesman — or at the very least, get a good ballpark figure. There are numerous places to go online to calculate what your monthly payment would be.
Let’s run through a few quick scenarios where your loan amount is $25,000, your loan term is 60 months, and see what payments would look like for excellent credit versus bad credit:
|Excellent Credit||Bad Credit|
|Used Car||$455 per month (3.53% APR)||$639 per month (18.33% APR)|
|New Car||$446 per month (2.7% APR)||$561 per month (12.42% APR)|
Before you get either excited or frustrated by these numbers, know that the length of the car loan is affecting what you see. Payments can be lower each month if you opt for a longer loan term.
The downside to this is, of course, that you will pay more over time. So, if your wallet is stretched, but you genuinely need the car you’ve been looking at, consider negotiating for a longer term.
How long does a typical auto loan last?
These days loan terms vary between 60 and 84 months. But remember: the longer the term the more you’ll pay in the long run. If you want to be financially secure, you have to stop thinking month to month and start looking at the bigger picture.
Get Pre-Approved in Advance
So you don’t maneuver yourself into a corner and get pressured into signing a loan agreement you’ll regret later on, shop around for lenders before you even go and look at a car. First, it’s good to know what your options are, and second, doing so won’t hurt your credit score.
Why is that?
For pre-approval, lenders will check your credit by running a ‘soft’ pull of your credit report. In these cases, lenders aren’t doing a full credit report analysis, but are just looking at your score to determine whether they’d want your business.
Though it’s not the total picture, they can anticipate with a certain degree of accuracy what kind of customer you would be. Do know that the final APR you’re offered may vary once they have gone through your complete credit history.
Before you apply, it’s a good idea to keep your credit card balances low as high credit utilization will lower your credit scores. You should also focus on improving your credit as much as possible.
Buy Within Your Budget
Knowing what you can afford can actually be a bit confusing. What is important enough to spend money on, and what should you hold back on? Hey, at least you’re asking these questions!
There are three big things that eat away most people’s earnings. They are:
- Student loans
- Mortgage or rent
- Car loans
People rationalize spending a lot of money on cars and houses by being frugal in other areas, such as taking lunch to work, not wearing major design labels, or going to Redbox instead of the movie theater.
In reality, these expenses are small potatoes.
Though they are the cheaper options, they’re not going to help you take that vacation to Ireland you’ve always wanted or save up for a major investment. Small savings may help you get the car or house you want, but they definitely won’t help you retire early.
How much of your paycheck should go towards your car payment?
If you don’t want to worry about eating out or going to see that movie that caught your eye, and you also want to put away money to make an investment, many experts recommend only 10%.
That’s right. Only 10%.
Now, for most Americans, that’s not a lot to spend on a car at all, but it’s a safe amount. Consider that the average income in the U.S. is only $52,000 a year, and it becomes apparent people need to be more frugal — especially in this economy.
Yes, a car is a multi-year investment, and you can get insurance to help protect it. But financially speaking, cars are not good investments. They depreciate the moment you drive them off the dealer’s lot, and, new or old, they always need routine maintenance and pampering.
So, unless you drive for Uber, the only thing a car is ever going to do is eat up your paycheck. Knowing that, why don’t most people keep their appetites to a minimum and spend their money elsewhere?
After all, how you get from point A to point B doesn’t matter as long as you get there in a timely manner, safely and securely.
Save your money for something big that will give you more than you put into it. Save it for something that can give you the security you’ll need when you’re old. Spend only 10% of your income and you’ll never be anxious about spontaneous lunch dates with your coworkers again.