Experian, TransUnion and Equifax now offer all U.S. consumers free weekly credit reports through AnnualCreditReport.com.
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Just as you wouldn't set out on a cross-country road trip without first checking your car's tires and filling the tank, you shouldn't head out to finance a new car until you're confident your credit is in good shape. You can get your credit ready to buy a car by paying your bills on time, paying down debt and minimizing other applications for new credit.
When lenders assess your eligibility for an auto loan, they'll want to see that you have a steady source of income, a low debt-to-income ratio and a good credit score. These seven steps will help get your credit ready to buy a car.
1. Check Your Credit Report and Scores
It's possible to get a car loan even with a less-than-ideal credit score, but lenders may charge you a higher interest rate or require someone to cosign on the loan with you. Checking your credit report and credit score will show you where you stand.
What's a good credit score? Lenders' standards vary, but many lenders prefer borrowers to have a score of at least 700 on the FICO® Score☉ range of 300 to 850. A good FICO® Score ranges from 670 to 739; a score from 740 to 799 is considered very good; and a score of 800 or more is considered exceptional. Auto lenders use a specialized credit scoring model that differs from the standard FICO® Score. However, general-use scores and auto lending-specific scores are influenced by similar factors, so if you have a good FICO 8 Score, it's likely you'll also have a good automotive-focused credit score.
You can check your credit score for free through Experian. When you do, take a look at the listed risk factors to see what might be holding your score back. Addressing risk factors, such as high credit utilization, can help you improve your scores.
In addition to checking your credit score, you should also check your credit reports with all three credit reporting agencies (Experian, TransUnion and Equifax). You can check your credit reports for free once a week through April 2021 at AnnualCreditReport.com. Review the reports to ensure all the information is accurate. If you find anything wrong, contact the appropriate credit bureau to dispute the error and see if it can be corrected.
But what if your credit score still isn't where you'd like it to be? Taking the following steps below can help you improve your credit score and enhance your chances of qualifying for an auto loan.
2. Always Pay Your Bills on Time
Your payment history is the most important factor in your credit score, accounting for 35% of your FICO® Score. If you need to improve your scores, start by bringing any late payments current. Once you're caught up on payments, make sure you always pay your bills on time going forward.
When you have a lot of bills to keep track of, it can be easy to forget a due date. Consider setting up automatic payments or using reminders on your phone or calendar to help you stay on top of your payments.
Utility, cellphone bills and other monthly payments don't normally don't get reported to credit bureaus, but you can get credit for paying these bills on time by signing up for Experian Boost®ø. This free service reports your on-time bill payments—even Netflix®—to credit reporting bureaus, which can instantly improve credit scores based on your Experian credit report.
3. Focus on Paying Down Credit Card Debt
While you're getting ready to apply for a car loan, be careful not to take on any new debt. If you have existing credit card debt, reducing it can improve your credit score by lowering your credit utilization ratio. Your credit utilization ratio is a measure of how much of the available credit on your credit cards you're actually using; it's the second most important factor in your credit scores behind only payment history.
To calculate your credit utilization ratio, compare the total limits on your credit accounts to the balances. Lenders typically like to see a credit utilization ratio of 30% or less. For example, if your total available credit is $12,000, carrying a balance of $5,000 (41% of the available credit) could start to do damage to your scores. The balance-to-limit ratio on individual cards is important, too, even if high credit utilization on one card is offset by low utilization on the others.
High credit utilization raises the level of risk you present in the eyes of lenders, which might make them more wary of taking you on as a borrower. Reducing your credit utilization will also lower your debt-to-income ratio (DTI), which compares your monthly gross income with your total recurring monthly debt. Lenders look at DTI to decide if you'd be able to afford monthly payments on a loan or credit card.
4. Only Apply for Credit if You Really Need To
When you apply for credit, it can result in a hard inquiry, which can temporarily lower your credit score. The impact of a single hard inquiry on your credit score is usually minimal and typically lasts just a few months. However, if your credit report shows several hard inquiries within a short time, you may appear to be more of a credit risk.
How can you shop around for an auto loan without racking up too many hard inquiries? Credit scoring models know people applying for loans want to compare rates from a variety of lenders. If you submit multiple applications for the same type of loan within a certain window of time, credit scoring models typically treat these as one hard inquiry. The application window varies by the scoring company: VantageScore® uses a 14-day period, while FICO will group similar applications made in a 45-day period.
You can compare loan offers without generating any hard inquiries by getting preapproved for an auto loan. When a company checks your credit to preapprove you, it's generally considered a soft inquiry, so it won't show up on your credit report.
Keep in mind that preapproval is only a conditional loan offer. You'll still need to get final approval from the lender. However, preapproval can provide a clear idea of how much car you can afford and how much the loan will cost you. It can also give you more negotiating power at the dealership.
5. Dispute Inaccuracies on Your Credit Report
If you find something you believe to be inaccurate on your credit report, you can dispute it. Disputing an item on your credit report won't hurt your credit and could help it if a mistake that lowered your credit score is removed. For example, if a payment you made on time is reported by the lender as late, it can negatively impact your credit score.
Contact the credit reporting bureau that reported the error to file a dispute by phone, mail or online. The credit bureau will investigate with the creditor to verify the information. If the information can't be verified, it will be updated or deleted. If it's wrong, it will be corrected; if it's verified, it stays on your credit report.
Keep in mind, however, that you can't have information removed from your credit report simply because it's negative. If your creditor verifies a disputed item is correct, it will remain on your credit reports and continue to be factored into credit scores.
6. Save Up for a Down Payment
A down payment is money you put toward the purchase when you're financing a car. You'll typically need to make a down payment of at least 10% of the purchase price. If you're financing a car that costs $25,000, for example, you'd need to save up $2,500 for the down payment.
A larger down payment reduces the amount you'll have to borrow, which helps you save money over the life of the loan in several ways. Even if you expect to qualify for excellent lending terms, there are some good reasons to save up for a down payment of at least 10% or better yet, 20%.
- Lower interest rate: A higher down payment reduces the amount you'll have to borrow, which reduces risk to the lender. They'll typically translate that into a lower interest rate on the loan, which decreases the total amount you'll pay for the car by driving down interest costs.
- Lower monthly payments: With a smaller loan amount and lower interest rate, your monthly payments will be less than they would have been otherwise. This means you'll have more room in your budget to put toward other goals, such as buying a house.
- Less risk of going "upside down" on the loan: Cars generally lose a portion of their value in the first year. By making a large down payment (in the neighborhood of 20%), you cut down the risk that you'll end up owing more than the car is worth, which can cause problems if the car is totaled in an accident or you want to sell it before it's paid off.
Saving up for a down payment isn't technically a way to improve your credit score. However, if your credit isn't stellar, a larger down payment might persuade a hesitant lender to approve your loan application or offer you better terms on a loan.
Ready, Set, Buy
Poor credit can be a major roadblock when you apply for an auto loan. A good credit score can make it easier to get a loan with lower interest rates and better terms. To smooth the road to your new car, ensure that your credit report and credit score are in good shape before you set out for the dealership.