You’ve likely heard the doom-and-gloom talk about how lenders have put loans on a much tighter leash in our post-recession economy. And it’s true; lenders are no longer giving out a loan to any old person with a government-issued ID and a smile.
So what does this mean for you if you are in the car-buying market? How will you know if you are likely to receive financing or not?
Let’s take a look at what will likely determine whether or not you can source a car loan.
What Goes into the Car Lending Decision?
There’s a big misconception out there about car loans that we should clear up right away. Here it is: the ability to take out a car loan is not entirely dependent upon your credit score.
Yes, your credit score plays a huge part in the process (especially when the lender is deciding on what interest rate they will tack onto your loan). However, it’s not the only piece of the puzzle. During the underwriting process, which is a fancy way of saying while the lenders are plugging in your numbers and figuring out if you are a good candidate for a loan, you must provide income verification and information about your current debt load.
Your income needs to prove that you can afford the monthly payments as well as to pay back the entire loan, and your debt information must show that you have a healthy debt-to-income ratio after you take on this new loan. They even look at how much it will cost for you to insure the vehicle to make sure you are going to have enough money for everything.
What is a Good Credit Score to Buy a Car?
The current average FICO (Fair Isaac Corporation) for new car loans is approximately 690 to 719. This doesn’t mean that you cannot get a loan if you have below a 690 FICO score, but it does mean that you would need to have other supporting evidence that you are a good candidate. Also, you would probably pay a much higher interest rate if you were approved.
MyFICO.com offers an up-to-date chart on the interest rate you can expect to pay for various FICO score levels, depending upon the length of your loan. According to their chart, a “good” credit score to have in terms of an interest rate below 5% is between 690-850 for a 36 month loan.
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How to Get Off the Car Loan Loop Forever
Let’s shift our thinking a bit so that you can set yourself up for a solid financial future.
Did you know that you can stop the seemingly endless loop of car loans…forever? It takes some financial discipline, and a bit of time, but the first time that you accomplish this you should be on the freedom-from-car-loan cycle for life. Here’s how:
- Pay off your current car loan as quickly as possible. You can use resources such as ReadyforZero’s calculator to help with this process.
- As soon as your car is paid off (and you have a celebratory night out, of course), take the same payment you were making towards it and instead pay it to yourself. Open up a savings account titled something like “Car Loan Freedom”, and automatically deposit an amount of money each month that represents a car loan.
- Keep your current car until your account is fully funded and you can walk into a dealership or used car place and pay actual cash for the entire purchase.
- After you purchase your new-to-you vehicle, start the process of saving for your next car over again.
By doing this, you are setting yourself up for double interest benefits. The first is you will never pay a middle man or finance company interest again. And the second benefit is you will earn interest on the money sitting in your car loan freedom fund. How exciting!
Remember that if your credit score needs some work, your income cannot handle a loan, or you have too much debt, there are alternatives to purchasing a new vehicle. For starters, you can purchase a “beater” car for a few thousand dollars. I’ve only driven beater cars and they have lasted me for up to 6 years each without major repairs.
You can use a combination of public transportation, car sharing, and car rentals. Peer-to-peer car rentals have made it a cheaper option to rent a vehicle for short-term needs. In the meantime, you can save up for a vehicle, and work on your credit score by paying down your current debt and making consistent, on-time monthly payments to each of your bills.
Image Credit: Great Beyond