Like every other loan type, auto loans have credit requirements that are unique to that industry. Credit scores play an important role. But since there are so many individual lenders, the guidelines vary considerably from one lender to another.
That means that auto loans tend to be more forgiving than other types of loans, and it's often a matter of shopping until you find a lender who will work for you.
Here are a few tips that will help when looking for an auto loan:
The credit score you see may not be the score a lender uses
You should always be aware of your credit score before you even apply for an auto loan, or any other loan for that matter. However, it's important to understand that the credit score you get, whatever the source, almost certainly won't be the same score that your auto lender will use.
As an example, all 3 of the major credit bureaus—Experian, TransUnion, and Equifax—issue their own credit score. It might be possible that the credit score you have access to is from TransUnion, but the auto lender you apply with is using an Experian score.
Even within the data analytics company Fair, Isaac and Company (FICO), there are many different credit scores being used. You might be looking at your FICO Bankcard Score 5, and the auto lender might be using FICO Auto Score 8, which will be a little bit different since it looks at credit from the standpoint of an auto lender, and not a credit card lender.
There's also the fact that the free credit scores typically available are what is known as "FAKO" (fake + o) scores. That means that they're not actual FICO scores, but what are known as educational scores. In fact, the difference between a FICO score and an educational score can be 20 or 30 points—or more.
How your credit score affects your interest rate
So how much does your credit score affect the interest rate that you pay on your auto loan?
According to statistics compiled by Experian Automotive for the third quarter of 2016,1 average rates for various credit score ranges looked like this:
- Super Prime (781-850)—2.60% new, 3.40% used
- Prime (661-780)—3.59% new, 5.12% used
- Non-prime (601-660)—6.39% new, 9.47% used
- Subprime (501-600)—10.65% new, 15.72% used
- Deep Subprime (300-500)—13.53% new, 18.98% used
Down payment to the rescue?
Down payments can be important to lenders because they reduce the lender's risk. They also reduce the chance that you'll end up owing more on the car than it is worth, shortly after making the purchase.
Zero down payment auto loans have become extremely common in recent years. However, they are mostly reserved for people who have stronger credit scores.
Many auto lenders don't have specific down payment requirements. However, they will limit the amount of the loan, based on both your credit and your income. If the loan is insufficient for the car that you want to purchase, then you'll have to make up the difference with a down payment.
It can often help your application if you offer to make even a small down payment, say 10%. 20% is even more convincing since few people make a down payment that large on a car purchase anymore.
The trade-in on your current vehicle can also represent a down payment. So can a cash rebate from the dealer.
According to a recent report on Cars.com,2 the average rebate on a new car as of March 2017 was $3,563. If you're purchasing a new car with a $30,000 purchase price, a rebate of that size would represent nearly 12% of the purchase price. A trade-in or any cash that you want to put down will make the overall down payment even larger.
Unfortunately, cash incentive rebates are not available on used cars. However, you can still use either a trade-in or good old-fashioned cash for a down payment.
When a co-signer can help
If either your credit or your income are insufficient to qualify you for an auto loan, you can always offer to bring in a qualified co-signer. Naturally, your co-signer will have to have strong credit and a generous income.
Though auto lenders don't generally require co-signers, they can help to strengthen a weak application. This is particularly important if you have little or no credit history. You may need to rely entirely on the credit of your co-signer in order to qualify for the loan.
Where to get an auto loan: Different lenders, different terms
Even with all of the information that is available in regard to car loans, it's important to understand that these are only averages. The auto loan market is much more decentralized than other loan types, particularly mortgages and student loans. Since there are literally thousands of banks, credit unions, and finance companies making auto loans, the guidelines are specific to each lender. For example, my own credit union will do 100% financing with a minimum credit score of 650.
You should shop around, starting with your own bank or credit union, and see what kind of a deal they can make for you. If you are unsatisfied with that offer, let the car dealer make you a better deal, or continue to shop between banks and credit unions.
Understanding your credit scores is the key to finding the best rates on any loan, but especially your auto loan. Often, lenders will use a different score than the free one you see. Making a down payment can make up for the differences in these scores.
1. Experian Automotive, State of the Automotive Finance Market, Melinda Zabritzki, Q3 2016 http://www.experian.com/assets/automotive/quarterly-webinars/2016-Q3-SAFM_Audio.pdf
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