Can you buy a cruiser or a clunker? Only your credit score knows for sure. Outside the purchase of new home, buying a new or used car is probably about as big a purchase as one can make.
While a few cash flush consumers have the luxury of paying outright for their cars, the rest of us usually rely on some combination of cash down and a three, four or five year loan. Whether we secure financing through our own bank or let the dealership do the legwork for us, it is our FICO or credit score that determines how much we can borrow and at what interest rate. To avoid last minutes snags in your next car purchase, do a little prep work ahead of time.
Step One – Know Thy Credit Report
Before you set out to buy the car of your dreams, make sure your credit report is not a nightmare. There are a number of services, such as freecreditscore.com, that allow you to view your report. Check it thoroughly for errors, such as accounts you've closed that still show open, or loans paid off that still show a balance. According to the United States Public Interest Research Group, as many as 80% of credit reports contain some errors, with over 20% being serious. The major credit bureaus, Experian, Equifax and TransUnion, may have slightly different data, so do your homework with all three. If you do find errors, you can dispute them with the agency in question. If it all looks good, turn your attention to your credit score.
Step Two – Know The Score and What it Means
Lenders use a scoring system to determine the amount of risk associated with your loan. Ranging from a low of around 330 to a high of 830, the scores are calculated by looking at various factors including payment history, amounts owed, length of credit history, balance to credit limit ratio, foreclosures and bankruptcy. Any score below 580 is considered a bad credit risk. If your credit score is between 580 and 620, you can probably secure a loan, but it will likely come with a very high interest rate and/or require a large down payment; many lenders consider 620 to be the dividing line between good and bad credit. Don't be discouraged; you still have time to improve it. A score between 680 and 720 is considered very good and will generally land you a traditional loan with as little as 5 percent down. A score of 720 or better can secure the best deals, such as near-zero percent financing and more favorable loan terms. If your score is below 700, don't be discouraged; you still have time to improve it.
Step Three - Fix it Now, or Pay Later
A poor credit score can be improved upon in a relatively short time. If you're not desperate for a set of new wheels tomorrow, take the time to raise your credit score and save some cash in the long run. A better interest rate, even at just a percentage point or two, can add up to thousands saved over the life of the loan. Here are some tips to help you get started:
- Pay off credit cards – even if you've never missed a payment, holding a balance of 50 percent or more of your available credit is a red flag to lenders and may signal you have trouble paying off debt. If you have a chunk of money saved up for a down payment, consider using some of it to pay down your credit cards.
- Be up to date on all your loans and pay your bills on time. A couple of missed payments, even over a period of a year, can deduct 10 or more points from your score.
- Avoid applying for new credit until after you've secured your car loan and keep the number of open credit cards between 3 and 5 max. Don't cancel credit cards you've held for awhile. Even if you don't use them, it bodes better for you credit score if the accounts show active.
- Plead your case. If you can't pay down your loans, make the case that you're not a bad credit risk. If you've held the same job for a number of years, have savings in the form of cash, CDs or stocks, or have significant equity in your home, a lender may consider these as assets when calculating the final loan terms.
Step Four –Ask Yourself, "Can I Afford It?"
As Mick and the boys famously sang, "You can't always get what you want, you get what you need." If you're unable to secure a loan for the amount required to buy a new car, consider looking at a used model. Many manufactures now offer Certified Pre-Owned cars that have low mileage and come with a full warranty. Better still, most lenders offer the same new car interest rate on previously owned vehicles less than two years old. Since you have more negotiating room to haggle the price of a used car than a new one, the right amount of persistence may save you thousands of dollars and land you in a well-maintained pre-owned version of the model you originally desired.
Finally, if nothing here works to help you secure a reasonable loan, put off purchasing a new car and work on repairing your credit. There's no need to get in over your head with a payment that straps you for cash and impedes your ability to pay down your other debts. If you're drowning in debt and can't pay off the balances, contact your credit card company and see if they are willing to renegotiate or forgive part of the loan balances. Start by offering 20 or 30 cents on the dollar and go from there. A move this drastic will probably preclude you from getting a loan for least a year or two, but you'll be able to rebuild your credit score in the mean time. There will always be a new or used car waiting on the lot, so take a few months and work toward getting your credit in shape. A little self-discipline now will go a long way toward enjoying your new car purchase in the future. You will be able to buy a cruiser instead of a clunker. To see your credit report, visit Experian, the preferred credit report provider for AutoTrader.com.