Do you know your credit score?  If you don’t, you should.  Your credit is the most important factor in obtaining an auto loan, especially in today’s credit-tight economy.   Although most people don’t like to think about the subject of auto financing (they would much rather focus on the shiny new car), it is actually the most important factor in car buying.  Your credit can not only make a significant difference in your interest rate and monthly payment, but it can even dictate what car you are “allowed” to buy!  So, how does your credit score affect your auto loan?

Let’s first take a minute to discuss what is meant by “good credit” and “bad credit”.  Your credit score (known as your FICO score) can range from 300 to 850, and it is an indicator of how likely (or unlikely) you are to repay a loan.  Every lender looks at scores a little differently, but most consider 740 and above to be “excellent” credit.  With a credit score in this range, you are considered highly responsible and trustworthy and, therefore, qualify for the best interest rates available.   Consumers with excellent credit can see traditional auto loan rates as low as 1.99%!

FICO scores below 650 are considered “subprime”, and consumers in this category must pursue what is known as “secondary financing”.  Secondary financing lenders currently charge rates ranging from 6.5% to 18%, depending on your credit profile.  If your score took a hit due to a “life event”, such as a divorce or a medical crisis, but you are otherwise financially responsible, then lenders may cut you a break.  If your score is low, but your income is high and you make a significant down payment, then you may also come away with a reasonable rate.  On the other hand, if you have a history of not paying your bills, then lenders will consider you “high risk” and charge you an equally high rate.

Lenders may also place restrictions on the type of car you can purchase if your credit is less than perfect.  Why do they care what kind of car you buy?  Since there is a higher risk that you will not repay the loan, the lender needs to be sure it can recoup its money by selling the car.  Many secondary financing lenders restrict higher-risk borrowers to a newer car with < 70,000 miles and require a 20-30% down payment.   The lender may also require the borrower to purchase the vehicle from a franchised dealer (i.e. Heimlich Honda) instead of from a private, used car lot (i.e. Bubba’s Auto Sales).  Oddly, this often makes it easier for someone with bad credit to buy a newer, more expensive car than an older, cheaper car!

If your credit score is very low due to multiple repossessions or if you have no credit history and little income, then you may not qualify for a traditional loan at all.  Unless you can get a relative with excellent credit to co-sign the loan, you will have to purchase a vehicle from a “buy-here/pay-here” lot.  Buy-here/pay-here dealers use their own money to provide financing to customers with really bad or no credit.  They sell low quality vehicles at high prices and charge interest rates near 30%!  To make matters worse, very few of these dealers bother to report to the credit bureaus to help you build credit.

Your credit can mean the difference between a low monthly payment on a swanky, new car or a high monthly payment on a piece of junk.  Always know your credit score before setting out to purchase a vehicle (or anything else that you plan to finance)!  Thanks in part to the rising threat of identity theft, a plethora of services now exist (some of which are very inexpensive or even free) that allow you to stay on top of your credit.  You can get your online credit report by visiting the nation’s three credit bureaus:  Experian, Equifax and Trans Union.  If you need help understanding your credit report, talk to your financial advisor or a credit coach.