When determining your credit worthiness in purchasing a new car, dealers usually look at the following:
- the amount of credit that’s already been extended to you,
- how much of it you’re currently utilizing, and
- any defaults or collections against you.
If these red flags are found on your credit report, the dealer may raise their interest rates to cover the added risk.
A top-notch credit score can open many doors, whereas a substandard score can end up costing you several thousand dollars in interest payments over the life of the car.
What kind of credit score do I need to buy a car?
There are no ironclad rules about how high your credit score must be to purchase a car. Dealers will sell you a vehicle with almost any score, but lower scores come with higher interest rates.
Dealerships typically offer several interest rate brackets. Below shows a table of the possible interest rates consumers can potentially secure with certain credit scores.
| Credit score | Interest rate |
|---|---|
| Greater than or equal to 700 | Less than or equal to 5% |
| Between 650 and 699 | Between 5-10% |
| Between 450 and 649 | Between 10-25% |
Getting into the numbers, that means on a $30,000 car, someone with an excellent credit score will pay around $5,600 in interest on a 60-month loan. Whereas someone with very poor credit will pay closer to $17,000, which is a difference of over $11,000.
Additionally, customers with lower scores may be extended less credit, in which case, dealers will most likely ask for a larger down payment to offset the risk of financing a customer with a poor credit history.
What do car dealers see as red flags on a credit report?
Your credit score is the most important factor in determining the interest rate you’ll pay, but a credit report contains a number of other important details. These are several of the negative marks that could raise your interest rates.
Maxed-out credit cards
Having several credit cards is great for your credit score, but only if you’re frugal with them. Lenders like to see you utilizing around 30% of your available credit. Exceeding that, especially maxing out any of the cards, will give the impression that you’re already stretched beyond your means.
Ideally, maintaining a utilization rate of around 9% using the AZEO method is recommended, especially during the period before purchasing a car, since it has the potential to raise your credit score
Numerous credit card applications
Applications for loans or a new credit card typically trigger a type of credit check referred to as a hard inquiry. Each hard inquiry causes your credit score to dip several points, so it’s best to limit them to one or two every few months.
Collections
Unpaid bills that are sent to collections are some of the biggest red flags for a dealership offering financing. Collections indicate that you’re at high risk of default, since any negative remarks are typically associated with bills that are at least 30, if not 90 days, past due.
High debt-to-income ratio
Your credit report doesn’t directly state your income, only the level of debt you’re carrying. However, loan applications require an accurate statement of your income, and dealerships provide more favorable loans to borrowers with a debt-to-income ratio of less than 30%.
Cash advances
Most credit cards allow you to make cash advances, which is usually associated with a higher interest rate than those on retail purchases.
Your credit report notes these cash advances, and if you’re consistently using them to withdraw money, you’ll be profiled as a much riskier borrower.
Is it possible to buy a car with bad credit?
It is possible to a buy a car with bad credit in accordance with the strategies below, however these options should only be considered as a last resort since they typically involve high interest rates.
Fortunately, these high interest rates don’t need to last forever. Making timely payments for a year or more can significantly raise your credit score, as can paying down other debts or increasing your income.
This improved credit score will then allow you to refinance your loan at a lower interest rate.
No credit check loans
“No credit check” financing sounds attractive to buyers with low credit scores, however, in this case, the dealer would typically forgo any credit checks because they would offering loans with exorbitantly high interest rates.
Higher downpayment
Another possibility for buyers with a low credit score is to make a higher down payment in exchange for a lower interest rate, but this isn’t an option for many people who are living paycheck to paycheck.
Pre-approval
To increase your odds of securing financing with favourable terms, it’s a good idea to get pre-approved for a loan before you even start shopping for a car.
Numerous online and local banks offer pre-approved auto loans, and having one in hand increases your negotiating power dramatically.
Many dealers try to beat the pre-approved offer to secure the profitable financing agreement, even if the interest rate is lower than what they would have offered you otherwise.
Second chance financing
Dealers also have more flexibility in their financing, offering “second chance” car loans particularly to borrowers with especially poor credit.
These loans often have exceptionally high interest rates, but with a longer repayment period to keep monthly payment affordable.
As a result, you’ll end up paying considerably more over the life of the loan, but it may be your only option for financing with poor credit.
Cosign
Another option for borrowers with poor credit or too little income is to have someone cosign the loan.
Having a cosigner with good credit can lower your interest rate considerably, but it puts them on the hook for any payments that you’re unable to make.
It can also lower their credit score, as the loan will increase their debt-to-income ratio.
Check the right online score
To avoid any surprises at the dealership, it’s a good idea to go online and check your credit score beforehand.
Accessing a free credit report before going to a dealership will allow you time to rectify any errors. It will also provide you with an idea of the interest rate you’ll likely be offered as well as what you’ll be able to afford.
Unfortunately, the scores found on free credit reporting sites can differ from the scores your dealer is seeing when they run a credit check.
The three major credit reporting agencies (TransUnion, Equifax, and Experian) all generate credit scores that are slightly different.
Sites like Credit Karma pull their scores from TransUnion and Equifax, which use the Vantage scoring system. Dealerships on the other hand, along with Experian, use FICO scores.
Vantage scores are typically higher as they are more heavily weighted towards on-time payments. Whereas FICO scores are more affected by hard inquiries, as a result of any loan or credit card applications, the consequence of which will affect your FICO score for 45 days, therefore lowering your score temporarily.
Free credit reporting sites like Credit Karma scores are helpful guides, allowing you to track how your score changes over time.
Requesting your Experian credit report would be the first step to determining the level of interest rates you’ll be offered.