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Financing A Car? Why Your Credit Score Matters
14 November

Financing A Car? Why Your Credit Score Matters

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Car Loans Canada

When people are looking to buy a new car, they typically focus on the car itself. It makes sense since you want to make sure you pick the right vehicle that comes with the features you want, but did you know that having a good credit score is just as important if you plan on financing your vehicle?

Generally speaking, consumers with a higher credit score will get better rates and terms which is why you want to ensure your credit score is in good standing. Don’t worry if you don’t know what your credit score is, in this article, we’ll tell you how to check your credit score for free and how to improve it before you get a car loan.

What is a credit score?

Every Canadian has a credit score which is a number between 300 - 900. The higher your number, the better your credit score. This number may not seem important to some people, but it’s vital information to lenders who want to know if you’re creditworthy.

Think about it, if a lender is going to extend you credit or a loan, they want to ensure that you’re going to pay them back. A high credit score shows that you have a history of making payments which will make lenders feel more comfortable when they extend you some funds.

If you haven’t done so already, check your credit score for free with Borrowell to see how you’re doing.

Standing

Poor

Below Average

Fair

Good

Excellent

Credit score

300-574

575-659

660-712

713-740

741+

How your credit score is calculated and how to improve it

People buying items with credit.

Your credit score isn’t a randomly generated number, it’s actually based on five different factors with various weightings. Once you understand how these factors work, you can take steps to improve on them which means a higher credit score. Here are the five things that affect your credit score.

Payment history

When it comes to calculating your credit score, your payment history accounts for 35%. This makes total sense since lenders will want to see that you’re consistently making payments on time. Keep in mind that your payment history doesn’t just apply to credit cards and loans, recurring bills such as your internet and cellphone also get reported to the credit bureaus which help you establish a credit history.

Credit utilization ratio

The amount of credit you’re using in relation to how much credit you have access to is known as your credit utilization ratio and counts towards 30% of your credit score. Let’s say you have an overall credit limit of $5,000 and you consistently maintain a balance of $4,000; your credit utilization ratio is 80%. Even if you pay that balance off every month, lenders might still be concerned that you’re constantly carrying a high balance.

Interestingly enough, lowering your credit utilization ratio is easy. You could simply just not charge that many things to your credit card. Alternatively, you could ask your lender for a credit limit increase. For example, if your credit card provider doubled your credit limit so you now have a total of $10,000 in credit available, your credit utilization ratio would instantly drop down to 40% which is much more reasonable than 80%.

Credit history length

As soon as you get a cellphone contract under your name or get your first credit card, you establish a credit history which is a good thing. Lenders want to see that you’ve had access to credit for some time since it counts towards 15% of your overall credit score. Some adults get caught off guard by this since they’ve always had their services under their parents or a spouse’s name. Only the primary cardholder or the main account holder gets their credit history reported so it might be a good idea to get your own credit card if you haven’t established a credit history yet.

New credit applications

Whenever you apply for a new type of credit, your credit score will usually drop by 10 points. When lenders are processing your application, to want to see if you’ve applied for a bunch of credit recently. This only counts for 10% of your credit score calculation, but you still don’t want to be putting in a bunch of applications around the same time since lenders will wonder why you’re applying for so much credit.

Types of credit used

Finally, there are the types of credit used that also counts for 10% of your credit score calculation. In the past, this was a slightly bigger deal as the type of credit you used could imply how you used credit. For example, someone who constantly used their line of credit could potentially have cash flow problems. Generally speaking, this isn’t a big deal anymore when determining your credit score.

How your credit score affects your car loan

Guy making a purchase with credit.

As mentioned, a higher credit score will likely get you a better interest rate and term when you’re financing a new or used vehicle. It’s important to note that every lender has different criteria when deciding on what rates to offer you, but a good credit score definitely works in your favour.

According to Experian , one of the credit reporting agencies based in the United States, the average credit score of people buying a new car with financing was 718 while used cars was 659.

Just because you have a low credit score doesn’t mean you won’t get access to auto financing. However, you may have to pay quite the premium since lenders are taking quite a risk by extending you money.

Those with an excellent credit score typically get the best rates as lenders will feel pretty confident that they’ll be repaid.

Although car dealers have their own financing options available, you’ll want to shop around for loans to see if you can get better rates. If you’re purchasing a used vehicle and require financing, then you’ll definitely need to shop around. Remember, you can get pre-approved for a loan before you buy so you’ll know exactly how much car you can afford and what your payments will look like.

What good auto financing looks like

Generally speaking, the lower the interest rate you’re offered, the better off you’ll be. That said, you need to factor in the term too. For example, a rate of 4.20% for 5 years is better than 4% over 7 years since you would pay less interest over a 5-year term. Extending the term lowers your monthly payments, but again, you’ll pay more interest over the term.

Beyond the interest rate, you’ll also want to make sure that your auto financing comes with prepayment options. This would allow you to pay off your loan quicker which in turn means less interest paid.

Another thing to consider is the price of the vehicle. Getting a good interest rate can be easy, but if you’re financing a car that will blow your budget, you may run into some serious cash flow issues. Some people suggest you shouldn’t spend more than 35% of your take-home income on your vehicle, but you may want to stick between 15-20% to ensure you can meet all your other expenses such as housing, groceries, vacations, entertainment and savings.

Final thoughts

If you plan on financing a new or used vehicle in the near future, you’ll want to take steps to improve your credit score. By making a few small changes to your spending, you could save big in the long run.

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auto loans   
bad credit car loan   
car buying   
credit score   
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