You want to get a good deal on a car loan but worry it will be challenging due to your credit health. If you can hold off on buying right away, you can implement strategies to build your credit before buying a car. Be mindful that the lender will likely assess your ability to afford the loan by computing your debt-to-income (DTI) ratio. Consider paying down any existing debt to bring down your DTI ratio alongside other methods of improving your credit score.
4 ways to build your credit before buying a car
Your credit rating plays a significant role in the interest rate you receive for a car loan. So, you want to get your credit in tip-top shape before you apply, starting with these actionable tips.
1. Dispute errors on your credit report
Start by getting a free copy of your credit report. Review the contents for accuracy and highlight any errors you notice that could be dragging your score down. Next, file a dispute by mail, phone or online with the credit bureaus — Experian, TransUnion or Equifax — reporting the inaccurate information.
The credit reporting agency will reach out to the creditor, lender or information furnisher to further investigate your dispute. If the information in your report isn’t verifiable, it will be removed, and your score could improve.
2. Pay your bills on time
Payment history accounts for 35 percent of your FICO credit score. If your credit card or loan account reaches 30 or more days past due, a lender or creditor will likely report the delinquency, and your credit score could take a hit.
But if you make timely payments on your credit accounts your score could improve over time. It is equally important to bring any past-due accounts current to avoid further collection activity and damage to your credit score.
3. Lower your credit card balances
The FICO credit-scoring model favors consumers that responsibly manage their debt obligations. Consequently, the amount of debt you owe is the second-largest component of your credit score. Credit utilization, or the percentage of your credit line you’re currently using, plays a significant role in determining this.
Lenders like to see your credit utilization at or below 30 percent. If yours is higher, work towards paying down your balances to possibly raise your credit score and qualify for a competitive interest rate on an auto loan.
4. Avoid applying for new credit
Each time you apply for credit, a hard inquiry is generated and can drop your credit score by a few points. Even though the impact is temporary, multiple inquiries in a short period could hurt your score — apart from rate shopping for an auto or mortgage loan within about a two-week period.
Unfortunately, a slight drop in your credit score could mean the difference between a better interest rate — and consequently could cost you several hundreds or thousands of dollars more.
Why your credit score matters when getting a new car
Lenders use your credit score to gauge your creditworthiness and the likelihood that you’ll default on your loan payments. If you have good or excellent credit, you pose less risk to the lender. In turn, you will generally be rewarded with a lower interest rate. With a lower interest rate, your monthly payment will be lower, and your loan will cost less overall. Conversely, if your score is low the cost of borrowing is typically higher.
Bad credit car loan options
If you’re having trouble getting approved for a car loan, there are bad credit options. For example, buy-here, pay-here dealerships cater to borrowers with credit challenges — but often charge steep interest rates and should only be used as a last resort.
Consider reaching out to your bank or credit union first to determine if they will approve you for a loan based on the strength of your existing relationship. Online lenders could also be a good fit, and many feature a prequalification tool on their website so you can see if you are eligible and view potential loan rates.
The bottom line
A strong credit score, coupled with a steady source of income and low debt-to-income ratio could get you a good deal on an auto loan. So, it’s worth improving your credit health before you apply. And when you’re ready to apply, you should shop around to find the best options for your financial situation.