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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DCCU Car Loan Refinance Calculator: See What You Can Save

Your car plays a huge role in your survival. It gets you to work, takes you to the doctor, and influences the quality of your daily life. Cars are expensive assets, with most private vehicles purchased with loan agreements from banks and other financial institutions. While paying off your car loan is an unavoidable part of life, interest rates, loan terms, and loan conditions can often be altered in your favor by refinancing your car loan.

If your financial situation has changed for any reason or you want to put more money in your pocket, you may wish to take out a new car loan. As one of your most persistent financial obligations, you can save lots of money by changing lenders or adjusting the details of your loan agreement. When you act smart, a car is more than a form of transportation – it is a significant and reliable asset that can be leveraged to your advantage.

There are many good reasons to refinance your car loan, with each person needing to review their own finances and lifestyle options. Perhaps your income has grown? Maybe your credit has improved over time? Perhaps the economy has shifted and you’re paying more than you need to? Regardless of the reasons, car loan refinancing is about accessing better terms and saving money for your future.

Let’s take a detailed look at auto loan refinancing so you can calculate a better deal for you and your family.

What is car loan refinancing?

Changing your car loan may seem complicated, but it’s really quite simple. When you refinance an existing car loan, you are exiting your current loan and taking on a new loan under changed conditions. The outstanding loan amount is carried over to the new loan, but the repayment terms, loan conditions, and interest rate may be entirely different.

There are two basic ways to refinance a car loan, either with your existing lender or through a new provider:

  • If you have a good repayment history, more savings, or an improved credit score, you may be able to negotiate a lower interest rate on your car loan with your existing lender.
  • If your current lender is not meeting your needs, you can research new lenders and compare your options. Perhaps you can find a better interest rate or improved loan conditions with another lender.

Why should I refinance my auto loan?

Most people who refinance a car loan do it to save money. Potential savings are not always clear cut, however, with savings always based on a specific time period. For example, you may wish to save money on your monthly repayments, which could end up costing you more in the long run. The opposite situation also exists, with shorter loan terms and reduced long-term interest often leading to more expensive monthly repayments.

While there are countless reasons to refinance a car loan, the vast majority of cases fit into one of the following two categories:

1. Your finances have improved

If your financial situation has improved, you may want to refinance your car loan. Examples include a better credit score, new employment, or more savings. In this situation, refinancing your car loan can help you to get a better interest rate, an improved loan term, or more favorable lending conditions. For example, you may be able to remove the original co-signer from your existing loan.

2. Your finances are challenging

If you’re struggling to pay your living expenses or monthly bills due to high loan repayments, it may be time to make a change. In this situation, refinancing your car loan can give you access to lower monthly repayments. While you will end up paying more over time, sometimes you need to focus on the present. In this situation, refinancing can be a good way to consolidate your debt or improve your cash flow.

The pros and cons of car loan refinancing

There are a number of potential pros and cons associated with car loan refinancing. These factors are not set in stone, however, with each person needing to analyze their own financial resources and lifestyle situation in order to make the right moves.

Let’s look at the positive reasons for car loan refinancing, along with the reasons why you should hold off and think again:

When should you refinance your car?

There are many great reasons for refinancing your car loan, but it’s important to be careful. Generally speaking, refinancing is a good move if your financial situation has improved and you’re looking for better lending conditions.

Potential pros of refinancing a car loan:

  • You may be able to negotiate a lower interest rate.
  • You may need to secure lower monthly repayments.
  • You may be able to reduce costs and fees.
  • You may want to remove a co-signer from the loan.

When should you hold off on refinancing?

While refinancing your car loan can help to lessen your financial burden, it’s not always advisable when analyzed on a long-term basis. Generally speaking, refinancing is a bad move if your financial situation is challenging and there are other options available to you.

Potential cons of refinancing a car loan:

  • You may end up paying more interest over time.
  • You may end up extending the term of your loan.
  • You may need to pay an exit fee or other costs.
  • You may get a better interest rate but less flexible conditions.

How to calculate your car loan options

Before you can calculate your savings through refinancing, it’s important to understand exactly what’s on the table. While borrowing arrangements can seem complex, all loans function in much the same way regardless of what they’re for.

The following factors are central to every lending agreement:

Interest rates

Every commercial loan has an associated interest rate. This is the cost of borrowing money, and it has a huge influence on the amount of money you end up paying for your car. Your annual percentage rate (APR) is the total cost of repaying the loan over the course of a year. Along with the interest rate amount, it’s important to have a basic understanding of interest rate structures.

There are two basic rate structures: fixed interest rates and variable interest rates. Most car loans are fixed, which means the rate amount is locked in for the term of the loan. In contrast, variable rates go up and down depending on the lender, the loan arrangement, and the wider economic conditions. This can be good or bad, but it is always inconsistent.

Loan term

In the most basic sense, the term of a loan is the agreed time period taken to repay the loan amount. For car loans, this is widely dependent on the original value of the car, the amount of the initial deposit, the interest rate, and the repayment amount. The loan term is directly related to both the interest payments and the repayment amount. The shorter the term of the loan, the less money is paid in interest.

Loan repayment periods can be broken down into an amortization schedule. Understanding this schedule is a great way to analyze your loan and work out how much interest you will end up paying. If you want to improve your cash flow by lowering your monthly repayments, you will lengthen your loan term and end up paying more in interest payments over time.

Loan fees

Car loans can differ widely when it comes to lending costs and fees. There are lots of things to look out for, including origination fees, repayment penalties, late payment penalties, application fees, and annual fees. Many car loans will also have a designated refinance fee, which is the price you pay for setting up a new lending agreement.

On the other side of the coin, some financial institutions offer a cashback scheme for people who refinance from another lender. While this can seem enticing, it should never be the only reason that you change lenders. Each of these fees will be included in your loan agreement, but sometimes they are hidden in the fine print.

Loan conditions

Along with the interest rate amount, the interest rate structure, the loan term, and the lending fees and costs, there may be other conditions associated with a car loan. These conditions can vary widely between products and lenders, so it’s important to do your homework.

One example of a potential loan condition is known as a balloon payment. This is a one-off payment that is due at the end of the loan period. Other examples include the provision of a personal guarantee and the inclusion of a co-signer. Along with saving money, removing the original co-signer is a popular reason for car loan refinancing.

How to calculate potential savings

Once you have a sound understanding of the basic factors that influence car loans, it’s fairly easy to calculate loan repayments and potential savings. While it might seem complex, all lenders use the same basic financial information to identify good opportunities. There are many car loan calculators available on the internet, all of which require the following information to estimate monthly repayments.

  • Vehicle purchase price
  • Car loan amount
  • Initial deposit or trade-in amount
  • Loan term
  • Interest rate
  • Balloon repayment
  • Repayment frequency

If you have this information at hand, it’s easy to estimate repayment amounts and compare car loans. While the value of the car, deposit amount, and intended loan term are likely to stay constant between providers, the available interest rate can vary widely.

Steps to refinance

Once you have analyzed the pros and cons and calculated your potential savings, you can move ahead with the next stage of car loan refinancing. Online calculators are useful during the research and comparison phase. However, it’s important to contact lenders directly to review potential savings and lock in favorable terms.

The following steps should be taken in the lead-up to every refinancing deal:

  1. Get current on your existing car loan.
  2. Review your outstanding debt amount.
  3. Compare potential lenders.
  4. Obtain pre-approval before car shopping.
  5. Balance short-term and long-term gains.
  6. Apply for a new car loan.

Why DCCU?

If you’re looking for an easy way to refinance your car loan, DCCU is here to help. We offer fair and competitive lending alternatives to the major banks. We are 100% committed to improving the economic and social well-being of our members, so you can rely on honest advice and transparent costs with every single loan. We are proud to help people from a range of socioeconomic backgrounds, including low and moderate-income members.

DCCU is owned by our members, with our financial cooperative dedicated to “building lifetime relationships through personalized financial service.” When you choose DCCU, you will benefit from flexible loan terms, low interest rates, and accessible financing up to 100% of the car’s value. Our values are strong, and our message is clear: We are “a local neighborhood Madison credit union that stands for you.”

Along with great deals, we believe in reliable extras and friendly customer support. We offer a number of easy add-ons for car loans, including extended warranty protection and loan pre-approval. When you’ve been approved for a specific amount, you can go car shopping with confidence knowing how much you can borrow. Pre-approval can be a great bargaining tool at the dealership, with price certainty leading to better decision-making and more competitive deals.

If you’re looking to refinance an existing loan from another provider, please give us a call to find out more. If you’ve already refinanced your vehicle somewhere else, it’s not too late to save money by switching to DCCU. We may be able to lower your monthly repayment, reduce your interest rate, or alter the length of your loan based on your personal requirements.

At DCCU, we proudly offer a range of lending services across Madison and surrounding counties. As a not-for-profit credit union owned and operated by our members, we are always willing to lend a helping hand. If you would like to refinance your car loan or learn more about our services, please contact DCCU today.

 

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Test Drives – Eric’s Auto Buying Adventure Pt 4

Do some smart test drives before buying a new car.
Eric gets ready to test drive some potential vehicles.

Now that I am pre-approved for my auto loan and have done preliminary research on different vehicles, it’s time to get out into the field! This is “the fun part” of the whole experience, actually getting out and test driving the cars! Continue reading Test Drives – Eric’s Auto Buying Adventure Pt 4

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Auto Loan Pre-approval – Eric’s Auto buying Adventure Pt3

Auto loan pre-approval specialist, Katie
Katie Kruger, Branch Manager

It goes without saying that I’m going to need an auto loan to help finance a new car after my accident. Who has that kind of cash laying around or just sitting in your pocket? Continue reading Auto Loan Pre-approval – Eric’s Auto buying Adventure Pt3

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How Did I Get Here? – Eric’s Car Buying Adventure Pt 1

Auto Loans at a credit union Madison, Wisconsin
I can’t wait to get a new car!

There is no greater way to throw a nice, balanced lifestyle off course than with a sudden, unexpected expense. And a LARGE expense at that. Maybe it’s unexpected medical costs, or your furnace dying in the middle of winter. In my current situation, it’s a new vehicle purchase. Continue reading How Did I Get Here? – Eric’s Car Buying Adventure Pt 1

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