Understanding Your Credit and How it Affects a Car Loan
Credit scores … such a headache and yet a vital part of everyone’s financial life. Many people don’t know their credit score, and many more people only have an “idea” of the meaning of a credit score. Today, we’re going to go through a crash course of credit scores, how to get them, how to build them, and why you need a good score when applying for a car loan.
Simply put, a credit score is a number that tells lenders and other organizations how risky or responsible you have been with money and bills throughout your financial history. This score is one way lenders evaluate how likely it is that a person will pay back the borrowed money. Nearly everything that has to be paid on a routine basis can count towards a credit score. How on-time one makes a payment can affect their credit score; paying on time can raise it, paying late or not at all will lower it.
A FICO credit score is a score based on a credit calculation method based on the Fair Isaac Corporation. Most lenders and agencies use FICO when making a decision to offer a loan, credit card, etc. This is just the beginning however. Not only are there multiple types of credit scores, there are multiple types of FICO scores. The one we’ll look at today is “FICO Auto Score 8.”
Starting out and Building Credit
Here’s a quick crash course on how to build your credit if you are just starting out or in the process of trying to rebuild your credit.
- Get a credit card with a low credit limit that you can pay off every month. A secured credit card is also an option; it works like a debit card, but every time you replenish the money, it positively affects your credit score.
- Use the credit card every month and pay it off every month. Simply having a credit card isn’t enough. You need to prove you can manage debt, so you need to build it and pay it off in a timely manner. Start small and develop a spending plan. Sometimes it helps to limit yourself to certain expenditures, like using it to pay for your gas each week.
- Pay on time. Once you receive your bill, pay by the due date. Some credit card or loan companies have a grace period, but do not plan on working this into your regular payment routine. A grace period is for use in a time of emergency. Be sure to be very clear on your particular company’s grace period and late fee penalties.
- Control how many accounts you have. More isn’t always better, and credit organizations keep a tab on how many accounts you have open. Start with one, and slowly move up from there. Some people recommend that people play by the number “3.” Use one card for essentials like bills, one card that you can use to spend on yourself, and one card that is only used in case of an emergency – and watches and shoes don’t count as emergencies. Just make sure you pay all of them off on time.
- Check your progress. After six months, check your score. You can receive a report free from TransUnion, Equifax, and Experian.
- If you have been using a secured credit card, consider applying for an unsecured credit card after a year. If you have proven that you can manage debt with a secured credit card, having a card without a safety net could be another way to increase your credit. Keep following steps 2-5 and you should have a strong credit score within another year.
FICO Auto Score 8
FICO Score 8 is the most widely used version of credit score, and is used as a baseline score for someone seeking credit. This base credit score can then branch out for industry specific scores, such as the automotive industry. When seeking a car loan, most lenders will look at the FICO Auto Score 8 because this score indicates the likelihood their car loan will be paid-off and on-time.
A FICO Auto Score 8 ranges from 250-900 versus the base FICO score of 300-850. Like the base FICO score, a higher score means lower risk. Unfortunately, the public can’t view the FICO Auto Score 8. This type of FICO Score tells a lender the following information:
- Do you have other auto loans, current or previous, and if so, have you made on-time payments?
- Have you ever settled an auto loan or had it repossessed?
- Did a lender have to send your auto account to a collections agency?
These are the main factors that will either send up a green or red flag to an auto lender. Remember, they want to know if lending you money for a car is a risk, and if so, how high of a risk.
How does a FICO Auto Score Affect a Car Loan?
It comes down to whether or not the FICO Auto Score is good or bad. If you have a poor score, then you might get rejected, even if you have a stable income. Another consequence for people with a low credit score is the possibility of a larger required down-payment and higher interest rate. The higher interest rate would result in a larger monthly payment than someone with a better credit score and lower interest rate. Applying for and receiving a car loan with bad or no credit isn’t impossible, but be prepared for these two factors to change.
Sadly, having a stable income isn’t enough. Someone can have a six-figure salary, but if they have a low credit score or no credit at all, they will most likely face hardships when applying for credit or loans. Even if they get approved, they may get hit with a higher interest rate and a large down payment. It’s best to be patient and build good credit. It may take awhile, but it’ll be with you for life.