Understanding Your Credit Score and Your Loan Rates

When you’re ready to buy a new car, it can be a stressful time and getting the right financing can be tricky in the best of times. If you have credit problems, it can be even worse as you find that many lenders won’t give you money at all, and those that will, hit you with exceptionally high interest rates. Understanding your credit score and how it affects the loan process, however, will give you the first tool you need in getting your credit back under control, and get you on the road to better loan rates.

Loan Rates: the Baseline

Loan rates are the baseline factor that all loans have in common, whether it’s a car loan or a mortgage rate. This “loan rate” is expressed as an Annual Percentage Rate (APR) or the amount of interest you have to pay on your loan each year, based on the percent you still owe.

One of the biggest factors in determining the loan rate you get is your credit score. This score will mark you as a good or bad risk for lending—if you have a low credit score, the lender will assume that you either

1. Are a bad risk for lending, due to the likelihood (or lack thereof) of you repaying the loan.
2. Have too much debt already, and cannot afford to take more on. This is known as debt-to-income ratio.

Loan Rate Samples

Let’s assume that for a really high credit score of 720-850 nets you a $25,000 loan rate of 7.115%. If your credit score is in the next tier down, from 690-719, the interest rate might jump to just under 8%. If you are the next tier down, from 660-689, you could be looking at almost 9.5% interest rates. One more tier down, from 620-659, puts you at almost 10.5%.

While this may not seem like that much of a difference—a few tenths of a percentage here and there—the monthly payments add up significantly. At that first level your monthly payment would be around $775 a month. At the fourth tier down, you’re looking at $818 a month—$43 per month more, or $500 per year.

For many, this could put them over the top for being able to comfortably afford the loan. Also, if you stretch this out to the life of the five-year loan, you’re looking at paying thousands of dollars more.

Down Payments and Co-Signers

If you can, put together a large down payment, or consider finding a co-signer. This can increase your credit-worthiness and help you get lower interest rates. A co-signer with a good credit score shows that there is a responsible person willing to back you, while a large down payment shows that you may have the ability to properly pay down the loan.

Understanding the impact of your credit score on car loan rates will help you start on the road back to financial freedom.