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Credit Scores and Car Loans: What Drives Your Interest Rate?

Auto Loans, Credit Score, Loans, Personal Finance
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If you want to finance a new or pre-owned vehicle, you may wonder how your credit will affect the terms of your loan.

Credit matters when it comes to car financing, but it’s possible for someone with no financing history or shaky credit to finance a car. Be prepared to pay a higher interest rate, and be sure to make all of your payments in a timely manner to build credit and an excellent credit score.

We talked to Alex Ghim, a finance manager at a car dealership in Oregon, about the relationship between car financing and credit.

Which scores are pulled?

There are a lot of different types of credit scores, from FICO to proprietary scores, for each of the credit reporting bureaus — Experian, Equifax and TransUnion. Car dealerships typically pull auto-enhanced scores from up to all three reporting bureaus, according to Ghim.

Auto-enhanced scores range from 300 to 900 and put a greater emphasis on how you’ve handled car financing in the past. For instance, it will take into account whether you’ve made any late payments on auto loans, had any car repossessions, and settled or declared bankruptcy on an auto loan. This information is included in your regular FICO score, but auto-enhanced scores give it more weight.

Keep in mind that these scores are different from the credit-specific auto insurance scores that many insurance companies use.

What happens if you have a poor — or an excellent — credit score?

If you have a poor credit score, you may get rejected for a loan or get a loan at less favorable terms (read: high interest rate). Dealerships offer financing through credit unions, banks and manufacturers. People with a low credit score will likely have the hardest time financing through credit unions.

Individuals with low credit scores are also more likely to be asked for a down payment. Those with lower credit scores are generally approved for a smaller loan-to-value allowance and will need a down payment to cover the difference. Loan-to-value is the amount of the loan you’re approved for in relation to the value of the asset you’re purchasing.

Generally, credit unions and banks use a tiered system that dictates your rate in relation to your credit score. Those with excellent credit scores are more likely to get the best rates — depending on other financing qualifications, like income.

Does credit matter that much? What about a stable income?

While credit matters, it isn’t the only thing, according to Ghim. A stable income and a low debt-to-income ratio — the amount of debt you have in relation to how much you make — are also very important. For people with shaky credit, these factors play a larger role in whether or not they get approved for financing.

I have bad credit. Should I buy or lease?

Leasing and purchasing have similar credit qualifications, so getting approved probably shouldn’t be a factor in your lease vs. buy decision.

I’ve never financed a car, will I be able to get approved?

If you’re afraid that the old paradox “You need to have credit to get credit” will keep you from financing a car, you shouldn’t be. It can be harder to get a car loan when you’ve never had one before, but income stability and good credit should be enough to get you approved.

That said, you may have to pay a higher interest rate than those with good credit and a car-financing history. You may also need to provide a down payment.

This article was updated April 20, 2017.