Are you looking to buy a new car? You might want to check your credit score first because it impacts your monthly payment and how much you can afford. Improving your credit score while looking for a new car will put you in a better position for financing. We’ll share some strategies to boost your credit score and how poor credit can affect your purchase.
What Credit Scores Do Auto Lenders Use?
Each auto lender has different credit score requirements. Most of them will either use a FICO Score or VantageScore when assessing borrowers. These scores are similar, and both scoring models prioritize payment history above other categories. However, it’s good to know the differences in case your auto lender looks at your VantageScore.
FICO Score
FICO scores range from 300 to 850. A higher score helps you qualify for a better loan. A good credit score is sufficient for most lenders. Good scores range from 661 to 780. Super prime scores consist of scores above 720. The low end of super prime belongs to the good credit score category, while others fit in the very good and excellent category. A subprime score, usually defined as anything below 600, makes it more difficult to get financing. If you are deep subprime, you should improve your score before getting an auto loan. Consumers fall within one of these credit score categories:
- Poor: 300-579
- Fair: 580-669
- Good: 670-739
- Very Good: 740-799
- Exceptional: 800-850
Payment history and credit utilization make up 65% of your credit score. Length of credit history, credit mix, and new credit make up the remaining 35% of your credit score. You must have a credit card, loan, line of credit, or similar item on your credit report to qualify for a FICO score. In addition, the tradeline must be at least six months old. Debit card payment history does not get reported to the credit bureaus.
Auto lenders can also use your FICO auto score to assess your loan amount. This score places extra emphasis on car loan payments. Lenders can only benefit from assessing your FICO auto score if you’ve bought a car before and made loan payments.
VantageScore
For many years, FICO was the sole credit scoring model, but the three credit bureaus joined forces to create VantageScore in 2006. The younger of the two offers a more generous path to qualification. You’ll still need a tradeline, but it doesn’t have to be six months old. Just like FICO, VantageScore ranges from 300 to 850, but lenders may have different credit requirements for each score. Lenders may have requirements set higher for VantageScores than FICO scores or vice-versa. These are the categories VantageScore uses to assess your score’s quality:
- Poor: 300-499
- Fair: 500-600
- Good: 601-660
- Very Good: 661-780
- Exceptional: 781-850
Each VantageScore category is more accessible than the respective FICO score categories. For example, a Good VantageScore would only be a fair FICO score, demonstrating one of the differences between these credit score models.
Average Credit Score to Buy a Car
What is the average credit score for car buyers? Experian produces a report every quarter that sheds light on this question and provides several data points. The Experian State of the Automotive Finance Market report reveals car buyers’ average credit scores. Their Q4 2022 report revealed average credit scores of 735 for new cars and 675 for old vehicles. Additionally, 65% of the car financing went to prime borrowers, while 16% of the financing went to subprime borrowers.
Can You Buy a Car with a Poor Credit Score?
A poor credit score puts you in an unfavorable position, but you may have some options. While it is possible to buy a car with a low credit score, it comes with consequences that we have detailed below. Raising your credit score by a few points can help you avoid these disadvantages and get better terms.
Consequences Of Buying a Car with Poor Credit
- Paying A Higher Interest Rate: Lenders view applicants with lower credit scores as having higher risks. The lender can obtain the car as collateral, but cars depreciate in value each year. Lenders would rather have a borrower pay the loan than seize a declining asset. To mitigate default risk, lenders will set higher interest rates to obtain more money per month. That can increase your monthly payment by over $100 per month, depending on the interest rate and principal.
- Paying A Larger Down Payment: Borrowers can get around higher interest rates with high down payments. Sometimes, a high down payment is necessary to get approved when applying for an auto loan. Increasing your down payment gives you more negotiation leverage. Depending on your credit score, some lenders will require a higher down payment than usual just to qualify. Saving up for a larger down payment can slow down your path to owning a car, but that down payment will reduce your monthly expenses. You should build your credit score as you accumulate enough funds for a down payment. Turning bad credit into good credit may lower the down payment requirement and help you secure a lower interest rate.
- Buying A Different Car from What You Want: Low-credit borrowers may not get sufficient financing for a dream car. If a bank, credit union, or online lender only lets you borrow $25,000, you have fewer options. Some borrowers in this scenario may have to settle for a used vehicle. Experian’s quarterly reports always show a sizable difference between credit score requirements for new and used cars. New cars require higher credit scores because they are riskier for lenders.
- Having to Get a Co-signer: A co-signer can help you qualify for an auto loan, but it’s not easy to get one. That’s because of the risks of someone becoming a co-signer so you can get approved for a car loan. Co-signers become legally responsible for paying off your loan if you can no longer afford it. These individuals have nothing to gain and can get stuck with extra debt. Most people would never accept that type of bargain, and that’s why most co-signers are friends or family. Someone may become your co-signer if you can demonstrate your ability to pay back the loan. You will also have to find a willing co-signer who has a high credit score. A potential co-signer with bad credit will not help your chances of getting approved for a car loan.
How To Raise Your Credit Score to Buy a Car
Raising your credit score helps you access more loans and get more attractive rates. You can use these strategies to build momentum and end up with a higher credit score.
Pay Bills on Time
Making on-time payments demonstrates your ability to manage debt, and it’s important for both credit score models. Payment activity makes up 35% of your FICO score and 41% of your VantageScore. Getting this part right will help you build a strong score. Buying goods and services with a credit card and paying everything back on time will improve your credit score. You can also accumulate points or receive cash back from those purchases.
If you do not yet qualify for an unsecured credit card, you can get started with a secured credit card to build your score. Debit card activity does not get reported to the major credit bureaus and will not help your score. Consumers should monitor their expenses to avoid overspending and late payments. On-time payments will improve your score, but a few late payments can offset those gains and put you in a less favorable position.
Keeping Credit Card Balances Low
Credit cards can improve your score since the issuers report payments to the major credit bureaus. However, the same financial instrument can devastate your score if you fall behind on payments. High interest rates will make it more difficult to claw your way out of debt even if you make the minimum payment. Some people fall into the trap of making on-time payments on the minimum, only to then lose points on their credit score because of an excessive credit utilization ratio. Keeping your credit card balances low makes debt more manageable.
A low credit card balance will decrease your credit utilization ratio. This ratio makes up 30% of your credit score and measures your available credit limit against total debt. For example, if you have a $5,000 limit on your credit card and owe $1,000, your credit utilization ratio is 20%. Experts believe a 30% credit utilization ratio improves your credit score. However, a credit utilization ratio below 10% is ideal.
Avoid New Applications
When building your credit score, don’t apply for most loans. Applying for new credit can trigger a hard pull or hard credit inquiry. These pulls and inquiries can hurt your credit score and leave you in a bad position. A single hard credit check won’t do much to your score, but applying for several loans and lines of credit can have a more meaningful effect on your score. Lenders may think you’re in a financially desperate situation to submit several applications for loans and lines of credit. This category makes up 10% of your credit score, so it’s less significant than your payment history and credit utilization ratio. However, every point adds up, especially when building your credit score for an auto loan.
Get A Credit Builder Loan
The Credit Builder Loan is one of the best loans to get when raising your score. It’s a secured loan with a small principal, typically $500 to $1,000. Loan terms are between 6-24 months which makes it easier to add this loan to your monthly budget. Once you pay off the loan, you get access to the funds in the security deposit.
A credit builder loan isn’t the best choice if you already have a good credit score. However, it is one of the few paths for people with bad credit to demonstrate on-time payments and rebuild their scores. A credit builder loan can give you an edge and put you back in a position to qualify for traditional loans. Then, if you pay off traditional loans without any issues, your credit score will continue to grow. This trend will help you access higher loan amounts and lower interest rates the next time you need to borrow capital.
Monitor Your Finances
Closely monitoring your spending and savings can also help you improve your credit score. For example, if you have enough savings, you manage your spending well, or you get paid earlier, you will be on time for your bill or credit card payments, which negatively affects your credit scores.
