Auto financing has been around almost as long as the automobile itself, because cars have always been expensive. Credit rating agency Experian last pegged the average price of a new car at $38,723, but that was in the midst of the pandemic. We're now in the aftermath: Inventories are light and retailers are selling close to the manufacturer's suggested retail price (MSRP). It’s all the more important to understand exactly what your credit score is, how it impacts the cost and accessibility of a car loan, and what you can do if your credit score is less-than-stellar.
What is a Credit Score?
The Consumer Financial Protection Bureau describes a credit score as a tool to predict your ability to pay back a loan and make your payments on time. Several agencies have developed mathematical formulas that use your past financial information to create your credit score.
These formulas are known as scoring models, and they use information from your credit report, including:
- Your history of paying bills, including utilities, mortgages, rent, etc.
- The total of your current unpaid debt
- The total number of loan accounts you currently have
- How long you’ve had those loan accounts open
- How much available credit you’re currently using
- Any new applications for credit
- Whether you’ve ever had debts sent to collection, experienced a foreclosure, or filed for bankruptcy
How Do I Find Out What My Credit Score Is?
You should have a credit report in hand before you begin even shopping for a new car.
There are four companies that most lenders use to obtain a credit score: Experian, Equifax, TransUnion and Innovis. Your initial impulse may be to contact these agencies directly to obtain your credit report, but that may not be necessary.
Federal law dictates that you have access to a free credit report every year. As long as you haven’t pulled a credit report in the last 12 months, you can get one for free. There’s ONE online resource that provides this service free of charge, authorized by the federal government: AnnualCreditReport.com.
AnnualCreditReport.com will provide a free credit score from the top three credit reporting agencies: Experian, Equifax and TransUnion.
What Does My Credit Score Mean?
Credit scores range between 300 at the low end and 850 at the high end. A credit score over 700 is typically considered to be a good credit risk. In 2020, the average American credit score rose to 710. To understand where you are in the credit universe, this is a good guide:
781-800: about 23% of Americans fall into the “Super-Prime” category
661-780: about 38% of Americans fall into the “Prime” category
601-660: about 13% of Americans fall into the “Nonprime” category
500-600: about 21% of Americans fall into the “Subprime” category
300-499: about 5% of Americans fall into the “Deep Subprime” category
What Happens If My Credit Isn't Excellent?
To qualify for a car loan from most major lenders (including the captive finance options provided by auto manufacturers like BMW Financial Services, GM Financial, Ford Motor Credit, and Hyundai Motor Finance), you’re going to have to have a credit score over 661, which falls into what the industry calls “Prime” credit territory.
If you’re in the “Prime” or “Super-Prime” categories, you’re generally considered a good credit risk, meaning you won’t have any issues obtaining a car loan. However, if you’re at the lower end of Prime, or if you fall into the “Nonprime” or lower categories, you have more to think about.
For people at the lower end of the “Prime” category, you may find that you’re not eligible for the best finance rates advertised by captive finance companies. For instance, as we’re writing this, Volkswagen Credit is offering a 0% annual percentage rate for 36 months on the 2021 Atlas. The fine print lays out the catch, though: “For highly qualified customers through Volkswagen credit.” That means that in order to qualify for that loan, you need a credit score of 740 or higher. Using our guide above, you can see that only about 25 percent of Americans would qualify for such a loan.
People with credit scores lower than 740 will pay an increasingly higher rate the further down the scale their credit scores fall.
Experian provides a guide to help understand the average car loan in each of these categories, the average APR percentage rate, and the average loan:
In general, you’re probably ok searching for car financing from traditional lenders—your bank, captive finance companies associated with manufacturers, credit unions—if your credit score is above 550. If it's lower than that, you’ll have to look for different options.
Lending Options for Poor Credit
Most people simply decide to buy a car and get it financed at the car dealership, but no matter what your credit situation is, you’ve got a lot more options, some of which can put you in a better negotiating position than financing at the retailer.
Your Bank or Credit Union
Depending on your credit situation, you may end up with a better finance deal if you go through your own current bank or credit union rather than the dealership's finance department. At the very least, speaking with your bank or credit union ahead of time will provide you with some understanding of how much you can finance and what kind of rate you’ll be paying.
Banks and credit unions often allow you to borrow up to 120 percent of the purchase price, which lets you cover sales tax with the loan, too.
Finance in Advance with CarGurus
This seems like a chapter in a Kafka novel, but when a lender executes a credit check after you’ve applied for a loan, that alone has a negative impact on your credit score. It’s called a “hard inquiry,” and it takes place after you’ve applied for a loan and the potential lender reviews your credit history, and not just at the moment the credit report is pulled. “Hard inquiries serve as a timeline of when you have applied for new credit and may stay on your credit report for two years,” according to credit rating agency Equifax, “although they typically only affect your credit scores for one year.”
If you’re comparing lenders and they all execute hard inquiries within about two weeks, it should only count as one hard inquiry on your credit. That’s why you want to get all of your shopping for loan providers out of the way just before you visit the dealership.
Finance in Advance from CarGurus is a way to get pre-qualified for a car loan without a hard inquiry. Using Finance in Advance, associated lenders do what’s called a “soft inquiry” of your credit history, which has no impact on your credit score. That report is shared with multiple participating lenders, who can then respond to let you know whether you qualify for one of their loans and how much you might qualify to borrow.
Participating lenders include Westlake Financial, Capital One Auto Finance, and Global Lending Services. Finance in Advance provides you a financing dashboard to see the competing offers, along with rates and loan terms from each of the lenders.
Buy Here, Pay Here Financing
If your credit is in the sub-prime category, you’ll want to consider doing what you can to repair it. That means paying your bills on time, paying off high-interest, revolving credit usually associated with credit cards, and avoiding any unnecessary loans.
But sometimes life gets in the way, and your options are limited. "Buy Here, Pay Here" financing is one option that may be available to you, as long as you understand the risks.
This kind of sub-prime, bad credit financing is offered by independent used car dealers who specialize in vehicles that don’t get sold on typical franchised auto dealer lots. The cars may be older and have some miles on them, and they often don’t have more than a 30-day warranty, meaning that you’ll have to consider doing something like a pre-purchase inspection at an independent mechanic before you purchase.
The financing comes directly from the dealership. They essentially float you the money to buy the car after putting down a sizeable down payment on a used vehicle. According to the Commonwealth of Massachusetts Division of Banks, “Buy Here, Pay Here Dealers tend to be small, used auto dealerships catering to the subprime credit market. Subprime lending at Buy Here Pay Here dealers may carry high interest rates and fees.”
According to a 2018 National Independent Auto Dealers Association (NIADA) study, the average price of a car sold at these dealers was $7,004, much lower than the average price of a new or typical used car. However, the down payments for these dealers' sales represented a significantly larger portion of the cost of the car, averaging $950, or 13 percent.
The interest rates offered by Buy Here, Pay Here dealers are also significantly higher than on other options, reaching into credit card territory. The average auto loan from a bank or credit union usually carries a 3.25 to 5.32 percent APR, while a loan from a Buy Here, Pay Here shop “typically hovers around 20 percent,” according to CreditKarma.
That means you could be spending a lot more on your car payments. For example, if you financed $7,000 for 36 months at a rate of 4.5% through a bank, your monthly payment would be $208.23. If you financed the same loan at 20%, your rate would be $52 more every month.
Defaulting on any car loan is a bad thing, but defaulting on a loan at a Buy Here, Pay Here lot will result in an almost immediate repossession. The NIADA reported that about 45% of Buy Here, Pay Here car dealerships use trackers to make finding the vehicles easier if repossession is in the works.
You also need to understand the payment procedure. With a bank, you can usually pay online, setting up automatic payment schedules. But with a Buy Here, Pay Here shop, you may need to pay bi-weekly, and you might have to do it in cash, at the dealership.
Despite the negatives, Buy Here, Pay Here financing can be helpful as long as you keep up with the payments. It can assist in rebuilding your credit—if you can manage to pay your loan on time.
Repair What You Have
If you’ve got a car already, you’re almost always better served by putting the money into keeping it running. If you can put off buying a car while you’re trying to rebuild your credit history, do it. It’s almost always less expensive to repair your existing car than it is to buy a new one.
For example, according to financial publisher The Balance, the average annual maintenance cost to keep a car running is $1,000. That thousand bucks may seem like a lot to spend just to keep your old car on the road, but considering that the average down payment on a high-mileage, older car at a Buy Here, Pay Here lot is $950, you might be much better off spending that money on the car you’re currently driving.
Fixing the car you currently drive also has benefits when it comes time to sell it or offer it up as a trade-in on something else. A non-running car, or one that desperately needs tires and brakes, is going to be worth much less, even in a hot used car market. A well-maintained car with receipts for recent work is going to sell for more money privately.
When you're getting ready to purchase your next car, you’d be well advised to:
- Check your credit history using AnnualCreditReport.com
- Investigate your loan options with your bank, credit union, Finance In Advance, or other lenders
- If your credit ends up being sub-prime, explore your options with non-traditional lenders, but understand the risks
- Consider holding off on a car purchase until your credit history improves
The Federal Trade Commission provides some excellent guidance on repairing your credit, which can not only improve your chances of getting a loan, but also lower the interest rate you’ll pay if you qualify.
Updated on: December 22, 2021