Understanding Your Credit Score and How it Affects Your Auto Loan

May 16, 2023

7

min read

I

magine the excitement of finally buying that brand-new car you have been dreaming of. But what if I say the key to unlocking that dream is just three little digits?

That’s right- it’s your credit score that has the power to shape your car-buying aspirations and overall borrowing experience. Most lenders take credit scores as a litmus test to assess the trustworthiness and reliability of borrowers.

So this means your credit score has a huge role when financing your dream wheels. So, what should you know about your credit scores, and what are the impacts on the auto loan? Let’s find out.

Understanding Your Credit Score

Your credit score is like a report card for your financial performance, grading your ability to handle the borrowed debt.

Just as your GPA reflects your academic achievements, your credit score reflects your creditworthiness and history of managing credit and debt. This three-digit figure, typically ranging from 300 to 900, holds immense importance when it comes to borrowing.

But how does your credit score gets calculated? Various factors determine it, each carrying a different weight in the calculation. Some of which include:

Payment History (35%): This factor evaluates your track record of timely bill payments, loan repayments, and credit card balances
Credit Utilization (30%): It examines the percentage of available credit you currently utilize.
Length of Credit History (15%): The age of your oldest and newest credit accounts are considered.
Credit Mix (10%): A healthy mix of different types of credit, such as credit cards, loans, and mortgages.
New Credit (10%): The number of recently opened credit accounts or applications is assessed.

Your credit score is derived from these factors, and the resulting score determines your financial ability to obtain an auto loan or any other loan.

How Do Credit Scores Impact the Costs of Auto Loans?

The credit score holds tremendous power when it comes to auto loans. It can significantly impact the cost of your loan, with lower credit scores leading to higher interest rates and ultimately increasing the overall expense.

Let's explore this further by considering a scenario: you've applied for a 36-month new auto loan of $30,000. The table below illustrates how your credit score affects the interest rate, monthly payment, and total interest paid.

FICO Score	APR	Monthly Payment	Total Interest Paid
720-850	7.00%	$926	$3,348
690-719	8.10%	$941	$3,893
660-689	9.76%	$965	$4,728
620-659	11.93%	$995	$5,835
590-619	16.15%	$1,057	$8,049
500-589	16.97%	$1,069	$8,490

Source: myficocalculator ( As of May 2023)

As the table reveals, a higher credit score enables you to qualify for the loan at a favorable 7% interest rate. In contrast, a lower credit score can result in an interest rate of 16.97%, more than double what you'd pay with a higher score. Thus, the impact is clear: a lower credit score can substantially increase the cost of your auto loan.

Also read: Why Is A Good Credit Score Important?

How Credit Scores Impact Your Overall Auto Loan Journey?

Your credit score can affect beyond the interest rates. Here are a few other areas in the auto loan journey where you can see the impact:

Insurance Premiums

A low credit score can result in higher insurance premiums, as insurers often associate them with higher insurance risk. Studies have shown that individuals with lower scores tend to file more insurance claims. As a result, you may pay more for auto insurance if your credit score is low.

Down Payments

Generally, people with low credit scores are considered high-risk borrowers for defaulting. So, you may be required to pay a higher down payment to mitigate that risk for the lender.

Loan Approval

Securing loan approval can be challenging if you have a low credit score. Firstly, meeting eligibility requirements can be hard, and even if you qualify, gaining loan approval can be an uphill battle. This limited access to loans can significantly impact your ability to finance your dream car.

Loan Terms

Borrowers with lower credit scores often face less favorable loan terms. This can result in higher monthly payments, increased interest rates, and additional fees or restrictions attached to the loan. Thus, the overall cost of borrowing can be substantially higher for individuals with low credit scores.

Loan Options

With a low credit score, you have limited loan options. This means you must explore more alternative lenders or dealerships that specialize in working with subprime borrowers. This can affect the range of vehicles available and the overall borrowing experience.

What Is the Minimum Credit Score for Auto Loans?

There is no universal minimum credit score requirement for getting an auto loan. However, lenders' eligibility criteria and policies vary, and they may have their own requirements. So, the specific minimum credit score needed can vary depending on the lender.

That being said, a credit score of approximately 660 or higher is generally considered a good starting point to qualify for an auto loan with favorable terms.

What Are Other Factors Affecting Auto Loans?

While credit score is an essential factor, it's worth noting that lenders also consider other factors. Here are some of them:

Payment History

Your lender gives you money upfront with the trust you will eventually pay back later. Thus, they will look at your payment history to build that trust. But if you have a track of late payments, defaults, or accounts in collections. In that case, this can significantly impact your loan application as they indicate a potential risk in fulfilling your financial obligations.

Debt to Income Ratio

A person is saddled with many debts, whether credit card debt, student debt, personal loans, etc. The lenders know this loan won't be your only loan, so they analyze this ratio to evaluate your capacity to take on additional debt. It compares your monthly debt obligations to your monthly income. Thus, a lower debt-to-income ratio indicates a healthier financial situation and may improve your chances of securing the loan.

Credit History

Your credit history reflects your past experience in managing credit. Lenders generally prefer borrowers with lengthy credit histories, as it provides more information about their creditworthiness. A long credit history with a positive payment record strengthens your loan application. However, lacking a credit history or poor credit history can adversely affect your auto loan application.

Employment Status

Lenders assess your employment status and income to ensure you have sufficient income to afford the auto loan. Having a stable job with a reliable source of income enhances your loan application and demonstrates your ability to meet financial obligations.

Credit Utilization Ratio

The credit utilization ratio is the percentage of your available credit that you are currently using. Maintaining a low ratio demonstrates responsible credit management and can positively impact your auto loan application. Lenders prefer a lower ratio, ideally below 30%. Thus, keeping your ratio low shows that you are not overly reliant on credit and can handle new financial obligations like an auto loan.

What Are Alternative Options for Low Credit Scores?

If your score is below the lender's minimum credit score, it can be challenging to secure an auto loan. But don't worry; it's not the end of the world; you can explore options such as :

Subprime Auto Loan

Some specific lenders specialize in providing loans to individuals with low credit scores. You can explore subprime loans and apply for them. Although the interest rates may be higher, as you gradually improve your credit score, you may qualify for lower rates.

When considering loans, it is crucial to carefully review the terms, including interest rates and repayment terms. Take your time to shop around and qualify for the best deals. Here are a few recommended lenders that offer subprime auto loans.

Seeking Co-signers

You may also seek co-signers to increase the chance of loan approval and secure more favorable terms. Generally, the co-signer is recommended in the following scenarios:

If you are new to credit space, have no credit history, and have a low credit score.
If you have a lower income or a less stable employment history.
If you have a high debt-to-income ratio.
If you cannot afford the higher interest rates of a low credit score.
If you are looking to build or improve your credit score.
If you have someone willing to be your co-signer.

When someone co-signs the loan, they are responsible for repaying the debt if you default. So, before co-signing the loan, ensure they understand the responsibilities and risks involved.

Improve Your Credit Score

Don't be discouraged by your current low credit scores, as it can be improved over time. Check out our dedicated article on improving your credit score for detailed guidance.

Buy-Here-Pay-Here Dealerships

Consider dealerships that offer in-house financing, commonly known as buy-here-pay-here financing. These dealerships may have more flexible credit requirements and provide auto loans directly to buyers. However, be aware that interest rates at these dealerships tend to be higher, and the selection of vehicles may be limited.

Here are some of our recommendations:

Saving and Down Payment

A substantial down payment can offset the impact of a low credit score on your loan application. By borrowing less for the auto loan, you become a less risky customer, which improves your chances of loan approval and may help you negotiate better terms.

Conclusion

A credit score is a deciding factor in making or breaking your auto loan experience. Generally, a good score opens doors to better terms, while a low score presents challenges and limited options. But, having a low credit score does not mean the end of the world; alternative options are available. So, understanding your credit score and leveraging the available options can help you navigate the auto loan process effectively and secure favorable terms.