What Credit Score Is Required to Buy a New Car?
If you’re planning to buy a new car through auto financing, you better work on your credit score first. Not only does your credit score heavily influences your approval for a car loan, but it also affects the interest rate and loan terms if you get approved.
Why Credit Score Matters When Your Buy a New Car
Your credit score is a numerical representation of your creditworthiness—your capability and willingness to repay debt obligations and your likelihood to default on a loan.
Lenders set different credit score requirements for new car loans but the average score is around 700. Borrowers with credit scores of around 780 or higher receive the best rates and terms. In some cases, they may even qualify for 0% financing.
You can still get car financing if your score drops down to 500 or less although it comes with a higher interest rate and weaker terms. Generally, the lower your credit score, the more expensive is your vehicle loan.
To get an estimate of how much you can afford to spend on a car based on your credit score, use this Car Loan Calculator.
How Credit Score Affects Your Car Loan
A low credit score reflects a high probability of defaulting on a loan, which puts lenders at a high risk of not being paid back. If you get approved for a car loan, lenders will charge you with high interest to compensate for that risk.
- A high credit score of 700 to 850 usually commands an APR or around 4% or lower.
- An average score of around 650 to 699 will likely give you 6 to 10% APR.
- Low scores of 500 and below will likely have an APR of 15% or more.
Aside from interest rate, your credit score also influences your down payment. If you have a low credit score, you may be required by your lender to put a larger amount down on the vehicle. This is so that the lender can recover a large amount in a short period.
Your credit score also affects the type of car you can finance. If you have a high score, you may be qualified to finance luxury car brands, like Tesla and Porsche. As a low-risk borrower, lenders are likely to grant you a substantial amount of money to purchase the car because they anticipate that you will repay the loan. If you have a low credit score, however, the loan amount that you can borrow is likely limited and you will have to settle for low-cost alternatives like Kia and Nissan.
How Credit Score Is Determined
The credit score is calculated using a credit scoring model, like FICO or VantageScore, that estimates the probability of default based on your past credit transactions.
The most common factors that affect your credit score includes:
Payment History - How did you manage your past credits? Did you made late payments and defaults or have had a history of property repossession or bankruptcy?
Credit Utilisation - Did you max out or use your credit card above its credit limit? Generally, spending above the 30% credit card limit can cause your score to drop.
Length of Credit History - Ideally, the average age of all your debt accounts should be at least seven years. Shorter credit history might not be sufficient for lenders to assess your creditworthiness.
Credit Mix - A good mix of revolving loans like credit cards and instalment loans like mortgage should be managed efficiently to positively affect your credit score.
New Loans and Inquiries - Applying for several new loans negatively makes you a high risk borrower because it suggests that you’re in financial trouble. When you apply for a loan, the lender pulls out your credit profile from the credit reporting bureaus and this activity gets recorded in your profile as “hard inquiry”. So, while shopping for car loans is recommended before taking out one, do it within 2 weeks. All loan inquiries made within this period are counted as one.
Account Balances - The total balances of your current and delinquent accounts can affect your repayment capacity. High balances can be a financial burden, which hampers your ability to make on-time monthly repayments.
Trended Credit Data - Your balances and your credit line over the past two years allow lenders to see significant changes in your credit behaviour. If you’ve had a bankruptcy history five years ago but have been a responsible borrower for the last two years, this will be factored in the calculation of your credit score.
If you don’t know what information your credit profile holds, request a Free Credit Check.
What If You Have a Poor Credit Score?
As discussed above, you can still get a car loan if you have a low credit score although your chances will be slim. You will also be paying higher interest for the loan, and will likely have a limited choice of cars to buy.
Get a Bad Credit Car Loan
Also called as a subprime car loan, bad credit vehicle financing is usually your only option to buy a new car if your credit profile is laden with records of late payments, loan defaults and bankruptcy. It charges a higher interest rate than standard car loans to compensate for the high risk of granting you the funds. You may also be required to provide a large down payment to secure the loan.
Proof of Financial Capacity for Repayment
While your credit score is of lesser value to bad credit lenders, you need to prove your financial capacity to repay the loan by having a stable source of income. This can be proven by your latest bank statements, income tax returns, and most recent pay stubs if you are employed.
If you’re not employed but have a good source of income, like owning a business, being a pensioner or doing consultancy, you may also need to present supporting documents like Centrelink payments, financial statements and a notice of assessment from the Australian Taxation Office.
Pledging your car as collateral for the loan minimises the risk for lenders. They may slightly lower down the interest charge because they have a way of recovering their money in case you default on the loan. This is through repossession and selling of your car at a lower price.
Co-Signer or Guarantor
If your credit record is deemed insufficient by lenders to prove your creditworthiness, you may be required to get a co-signer or guarantor for your car loan. This person signs the loan contract along with you and pledges to take responsibility on loan repayments if you default. Ideally, a co-signer or guarantor must have a good credit score and a stellar credit profile to help you negotiate for better loan terms.
Work on Improving Your Credit Score First
If you don’t have an immediate need to buy a new car through an auto loan, it may be wise to improve your bad credit first before applying for a loan.
Request a free copy of your credit report from the credit reporting bureaus and check if all the information in your profile is accurate. Dispute any false entries you find. This can take you around a month or more, depending on the result of the CRB’s investigation.
If your dispute resolution is successful, the CRB will remove the erroneous information from your profile and your credit score will improve. If you’re not successful, the dispute will not have any further negative bearing on your profile.
Be a Responsible Borrower
If you have nothing to dispute, proceed to fix your bad credit habits. These include:
- Paying your bills on time
- Clearing up past-due balances
- Settling defaulted loans
- Reducing your credit card usage to 30% of your total credit card limit
- Enter into a debt agreement with your creditors
You can also boost your credit score by adding the utility and phone bills that you pay on time on your credit report.
Car Loan Refinancing
If you have no choice but to take out a car loan with high interest, you can refinance it as soon as your credit score improves and the car loan rates drop.
Refinancing a car loan involves taking out a new auto loan to pay off the existing one. By paying off your old car loan and taking out a new one with better interest rates or longer loan term, you can reduce your monthly repayments.
Make sure that your new can loan covers the total balance of your previous loan and the old account is closed after paying off the balance. See to it also that all fees associated with the car loan refinancing do not offset your potential savings.
Positive Lending Solutions helps clients across Australia find the right car loan for their specific needs and financial situation. Get in touch with one of our expert brokers on 1300 722 210 or request a Quick Quote.