How Your Credit Score Affects the Cost of Financing a Car

Tim Boyle | Bloomberg | Getty Images

Although new car prices are moderating a bit, financing the purchase of a vehicle has not become cheaper.

With the Federal Reserve latest interest rate hike — the sixth this year — car loans are about to get even more expensive. The Fed’s decision has a ripple effect, typically causing rates to rise on a variety of consumer loans and lines of credit (and some savings accounts).

The average price of a new car is around $45,600, according to a recent estimate from JD Power and LMC Automotive. This is down from the July high of $46,173.

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However, rising interest rates further drive up the overall cost to consumers financing their purchase. The average rate on car loan fell from an average of 3.98% in March to 5.60% in October, according to Bankrate.

And depending on a buyer’s credit score, the rate could be in the double digits.

“On a car loan, the difference between good and bad credit can add up to several hundred dollars a month,” said Ted Rossman, senior industry analyst at Bankrate.

Your credit score is one of many variables taken into account

The higher your credit score, the lower the interest rate you may qualify for.

This important three-digit number typically ranges from 300 to 850 and is used in all kinds of consumer credit decisions. Lenders also typically use information such as your income and other monthly expenses.

A good score is usually above 670, a very good score is above 740, and scores above 800 are considered exceptional, according to credit reporting company Experian. Scores below 670 are considered fair; anything below 580, poor.

The difference in interest rates available between different credit ratings can be striking.

By way of illustration: With a credit score in the 720-850 range, the average interest rate for a $45,000 five-year auto loan is just under 5.8%, according to the latest FICO data. This translates to monthly payments of $865 and the amount of interest you will pay over the term of the loan would be $6,890.

Compare that to what someone with a credit score between 660 and 689 would pay. That same loan ($45,000 over five years) would have an average rate of almost 9.4%, resulting in monthly payments of $942 and $11,514 in interest over the life of the loan. (See table below for other credit ratings.)

While it’s hard to know what credit score a lender will use – they have options – having a general goal of avoiding bumps on your credit report helps your score no matter which one you use, experts say .

“Many tips for building credit are more like a marathon than a sprint: pay your bills on time, keep your debts low, and show that you can successfully manage different types of credit over time,” Rossman said.

“That said, there are some things you can do to improve your score quickly,” he said.

Tip: Reduce your use of credit

His best advice? Reduce your credit utilization rate. “It’s the amount of credit you use on your credit cards divided by your credit limits,” Rossman said.

He said that even if you pay off your balances every month, credit reporting companies — Experian, Equifax and TransUnion — often receive balance data before you’ve paid it.

“It’s usually reported on your statement date, so consider making an extra payment mid-month and/or requesting a higher credit limit to lower your ratio,” Rossman said.

Check for errors on your credit report

Also, he said to make sure there are no errors on your credit report.

To check for errors and get an idea of ​​what lenders would see if they pulled your credit report, you can get a free copy from each of the three major credit reporting companies. These reports are available for free on a weekly basis until the end of next year.

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