How Your Credit Score Works For a Car Loan
Credit Scores. To some people, they are sacred, and to others, they are a game of never-ending catchup. Either pride or infamy accompanies the thought of a personal credit score. However, regardless of how you feel about your credit score when it comes to obtaining a car loan, it is a vital tool to know and understand.
Fortunately, if you can get approved for a car loan and keep up with the payments, your investment will improve your credit score. Once you are financially ready, getting an auto loan is one of the best ways to help your credit.
So, how does that all work? Here is an explanation of how your credit score works when obtaining a car loan:
What is a Credit Score?
A credit score is a number between 300 and 850 that determines your creditworthiness. This score develops from various factors that help creditors decide whether you are a high or low lending risk.
Creditors use your history, your income, and the number of current credit lines to figure out your debt to income ratio.
Your credit score is the number that gives them a summary of this information so they can quickly decide whether they should grant you the loan for which you applied.
This credit score is often called a FICO Score. When it comes to auto loans, though, even though they are directly related to your credit score, they work a little differently than traditional credit inquiries.
(Spoiler alert: This difference can sometimes work in your favor when trying to obtain an auto loan.)
Auto Interest Rates
Interest rates vary substantially, and that variation is directly dependant on your credit score. If you have a high credit score, you will have a better interest rate offer than a person who barely has a high enough credit score for approval.
What is an Interest Rate?
The interest rate is how lenders get paid. Leasing vehicles and awarding auto loans are big business, and if they only charged you what you borrowed, they would never turn a profit.
So, car leasing lenders determine an interest rate that corresponds with their level of risk when lending to you.
According to Experian, this is the data for interest rates in 2019:
| Credit Score | Average Intrest Rate for New Auto Loans | Average Intrest Rate for Used Auto Loans |
|---|---|---|
| 300 to 500 | 14.25% | 19.81% |
| 501 to 600 | 11.51% | 16.88% |
| 601 to 660 | 7.55% | 10.85% |
| 661 to 780 | 4.75% | 6.15% |
| 781 to 850 | 3.82% | 4.43% |
Remember, these are averages, and it is possible to find interest rates across the board, depending on your specific lenders, situation, and agreement. The critical thing to garner from this information is the stark difference in interest rates concerning your credit score.
Subsequently, the higher the interest rate (APR) is for the loan, the higher your monthly payment. This same information revealed that the average difference between having excellent credit and credit that needs improvement is $75 per month.
Breaking Down the Percentages
Sometimes percentages can be misleading. Paying an interest rate between 4 and 11 percent on a $100 purchase is not such a big deal. After all, the sales tax in some states is upwards of 7%.
However, when you are making a big purchase or borrowing a substantial amount of money such as when buying a car, that 5% can be a small fortune.
For instance, if you buy a $20,000 car and have a reasonable interest rate of 4.75%, you will only end up spending $20,950 for that car if you pay off your loan in one year. Yet, if you have an interest rate on the higher side, let’s say of 11.51%, you will end up spending $22,302 for the same car if paid off in the same amount of time.
The Relationship Between My Credit Score and My Auto Loan
When it comes to your credit score and your auto loan, it is a consistent flow of gives and takes. For instance, if your credit score is Deep Subprime and you get a loan, you will have a higher interest rate than a loan candidate with a non-prime, prime, or super-prime credit score.
However, suppose you continuously pay your bill on time and remain in good standing with your auto loan. In that case, it will play a more significant role in helping your credit score than if you were already an established prime or super-prime credit score holder.
Ironically, having a diverse portfolio of loans in good standing will help your credit much more than if you never took out a credit line. (This information is not to say that you should max yourself out on loans or credit lines of any kind. Yet, it is good news that even if you do not have a perfect credit score, the relationship between your credit score and your auto loan work together to help you overall.)
Whether your credit score is good or needs improvement, it pairs well with obtaining a car loan. Not only is a credit score necessary to get a car loan, but it also works in tandem with your car loan to help get your credit to an acceptable level.
Once you have achieved this level, and you use your auto loan to control your credit score, getting a car is only the first step into a world of possibilities.
