Credit Scores and Auto Loans — The Good, the Fair, and the Bad

Are you shopping around for a new car? Are you worried that your credit score will affect your borrowing options? A credit score is a simple number assigned to each person by one or more recognized credit bureaus. When you apply for a car loan or attempt to access any other kind of credit, this score is reviewed and analyzed by potential lenders.

Let’s review the credit score system in the United States, including some simple optimization strategies. When you have a basic understanding of credit scores and their implications, buying a new car can be easier than you think. 

Why your credit score matters

When people buy a new car, most of them need to take out an auto loan. Whether you’re borrowing from a mainstream bank, a car dealership, or a community-based lender, the institution lending you money wants to know how much you can be trusted with. They will use a variety of financial and employment records to measure your creditworthiness, and your credit score is a significant factor in this decision.

Above all else, lenders are interested in your ability to pay back the loan in the designated time period. Individual credit scores are an attempt to verify this ability based on historical data and current accounts.

What is a credit score?

Your credit score is a simple three-digit numerical expression produced by credit reporting agencies or bureaus. There are two primary credit score systems used in the United States. Fair Isaac Corporation (FICO) is the most widely used model, and VantageScore is a popular alternative. The former collects and tweaks data from multiple reporting agencies, and the latter collates data from three credit bureaus: Experian, Equifax, and Transunion.

Regardless of the model used, this number is based on a detailed analysis of your borrowing history and current credit files. While credit scores can seem like they’re set in stone, they do change frequently over time in relation to financial accounts and inquiries. Your credit score is widely used by financial institutions, along with utility companies, retail stores, and other entities that need to measure financial risk.

Personal credit scores are based on the financial history of each individual. Agencies use a closely guarded mathematical formula to collect and weigh data from multiple sources. Your credit score is also affected by open accounts, total amounts of debt, and repayment histories, among many other factors. While the credit score system leaves no room for discretion, it can be influenced by a number of factors firmly in your control.

In the United States, your credit score is a number between 300 and 850. Lower numbers represent less creditworthy individuals, and higher scores are likely to lead to more lending options. While not set in stone, the following levels are typically applied to auto loans:

  • Super-prime credit: 780-850
  • Prime credit: 660-779
  • Non-prime credit: 600-659
  • Subprime credit: 500-599
  • Deep subprime credit: 300-499

How your FICO credit score is created

If you want to improve your credit score, you need to have a basic understanding of how it’s created. Although there are slight differences between credit models, the basic information used to formulate scores is shared between agencies. And while the FICO score was developed in 1989 using secret algorithms, the way different elements are weighted has been released. 

According to FICO, the three-digit number assigned to you is based on the following factors:

  • Payment history comprises 35% of your score, which indicates your ability to pay bills on time.
  • The ratio between the outstanding debt and credit limits is weighted at 30%, which indicates the total amounts owed.
  • The length of your credit history makes up 15% of the overall score, which indicates your track record.
  • Credit account diversity represents 10%, which demonstrates your ability to manage different types of debt.
  • New credit makes up the final 10% of your score, which is based on recently opened accounts.

The link between credit scores and interest rates

Your credit score has a huge impact on whether or not you will be offered a car loan. Approval is not the only factor at play, however, with your score also affecting the interest rates available to you. As mentioned above, credit scores are one of the primary tools available to lenders to measure the risks associated with each loan. This is not a simple binary decision, as each lender offers different interest rates and loan terms in order to manage risk effectively over time.

People with a better credit score are generally deemed to be at lower risk, which means they are likely to be offered more competitive interest rates. While a compromised credit score does not always eliminate your lending opportunities, it will almost certainly limit you to certain interest rate brackets.

How do credit scores affect auto loans?

Not all loans are created equal, as mortgages are treated very differently from business loans, personal loans, and auto loans. In the United States, a prime credit score of 660 or above will give you plenty of car loan options, both from traditional banks and non-mainstream lenders. 

Prime credit scores are associated with very good interest rates, with highly competitive super-prime rates also offered by some lenders. Generally speaking, people with a prime or super-prime credit score will have access to the same lending opportunities, although the interest rates on offer may differ between these levels. If your credit score is below 660-680, however, you are likely to face higher interest rates and tough questions about your credit record.

If your credit score is below 600, you may have to meet more stringent documentation standards, and once again, interest rates are likely to be higher. If you’re down in deep subprime territory below 500, lenders will generally see you as a red flag. While people with bad credit scores can still get car loans in many situations, access to mainstream lenders may be ruled out.

How to optimize your credit score

If you want to get a car loan but have a less-than-perfect credit history, there are ways you can optimize your credit score. From checking reports and disputing errors to making payments and limiting new accounts, the following ideas are a great place to start.

Check your credit score

If you want to get a car loan, you should check your credit score first. This can help you to avoid nasty surprises and set realistic goals regarding car types, interest rates, and loan terms. According to the Fair Credit Reporting Act (FCRA), each of the three credit bureaus has to offer one free report each year when asked. You can easily check your credit report at AnnualCreditReport.com, with separate scores also available from each agency.

If you want to review your FICO score, there are multiple options available. Along with commercial credit monitoring and reporting services, there are a number of ways to review your FICO score for free. For example, American Express and Bank of America customers issue free FICO scores to all cardholders, and Discover Credit Scorecard and Experian Boost provide a free score to all registered users.

Identify credit score errors

After you have checked your credit scores, it’s important to review them for errors and monitor them over time when changes occur. Mistakes are more likely than many people think, including clerical errors, identification errors, and historical errors due to divorce, separation, or family breakdowns. For example, if your ex-spouse’s information remains on your personal credit report, it can lead to errors. If you spot any kind of mistake, you should gather evidence and contact the bureau that issued the incorrect report.

Make your payments on time

Along with checking your records and recognizing mistakes, there are lots of proactive things you can do to improve your credit score. While you won’t see the benefits immediately, paying your bills on time is the most obvious way to raise your credit score. From mortgage and business loan payments to credit card bills and utility accounts, all of your household bills play a role in setting your credit score. If you struggle to remember payment dates, setting up automatic reminders or even just buying a calendar can have a positive impact.

 

Limit your credit accounts

As mentioned above, your credit score is affected by the number of accounts you have open and the number of inquiries you make. From the credit cards in your wallet to the frequency of new applications, simplifying your financial life can have a positive impact. For example, you should avoid credit limit increases on existing products, new retail store cards, and anything else that’s likely to affect your credit score. If you need a new card or service, you can avoid many issues by submitting pre-qualification forms.

Leverage alternative credit data

If your standard FICO or VantageScore is compromised in any way, you may be able to take advantage of alternate credit records. While not all lenders are willing to look at these non-traditional sources, community-based lenders and other non-mainstream institutions often have a more flexible approach. While a scoring formula is still needed to help lenders make decisions, the following two options are available:

  • FICO introduced the UltraFICO score in an effort to improve credit options for low-income people. This scoring system is based primarily on your banking activity.
  • Experion created a similar alternative with Experian Boost, which takes payment data from your utility and cellphone accounts into consideration.

Get a cosigner

If you’re looking for a way to circumvent the credit score review process, getting a cosigner for your loan can be very useful. While you are still personally required to make payments over the term of the loan, the cosigner’s credit score is used during the initial approval process. However, it’s important to understand the details of this arrangement, especially that the cosigner is held responsible if something goes wrong. If you are not careful, this can have a range of financial, legal, and personal ramifications. The cosigner’s credit score is not the only thing checked by lenders but also their income and debt to income (DTI) ratio.

Find the right lender

Upgrading your credit score is a great way to improve your chances of getting a car loan. There is only so much you can do, however, especially if you need a new car in a relatively short period of time. Along with your credit score, it’s also important to focus on your lender. There are lots of options out there, from mainstream banks and credit unions to commercial car vendors and community-based financial cooperatives.

Generally speaking, mainstream banks and credit unions will offer the lowest comparative interest rates, but they’re also the least likely to accept people with a bad credit score. Commercial car yards are on the other side of the spectrum, accepting people more readily but also charging extremely high interest rates. Some community-based lenders offer the best of both worlds, with easy approval and flexible loan conditions combined with competitive rates and low fees.

The DCCU advantage

If you want to get a great car loan but have a less-than-perfect credit score, DCCU is here to help. As a community-based financial institution, our lending service is based on honest advice, flexible conditions, and competitive interest rates. We help people from a range of socioeconomic backgrounds to find car loans and access other lending services.

DCCU is owned by our members, and our financial cooperative is dedicated to “building lifetime relationships through personalized financial service.” As a local neighborhood credit union, we proudly deliver great products and friendly service to everyone in the Madison community. Regardless of your credit score or financial history, our team is willing to lend you a hand. Please contact DCCU to find out more.

 

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Jen M.

Jen has been with DCCU since she graduated from UW Madison - a long time ago. As the Content Strategist she helps share all the amazing things DCCU does in our community and spreads the credit union philosophy of People Helping People. When she's not working for the best credit union in south central Wisconsin, she's busy with 4 kids and a feisty little dog at home. She formed her family through adoption and has a deep passion to support foster and adoptive parents and kids. Her favorite place to relax is poolside or in front of the fireplace.