Risk-based interest rates let borrowers with dinged credit buy a car

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The little guys are pricing auto loans like the big guys, and savvy consumers may be able to cash in with lower interest rates while borrowers with shakier credit may get more opportunities for loans.

Small banks and credit unions have joined large banks, auto manufacturers’ finance companies and independent finance companies in offering risk-based auto loans.

In the old days, not that long ago, lots of lenders had a single interest rate for auto loans. You either got the loan or you didn’t.

With risk-based, or tiered, pricing, lenders — with the help of some sophisticated credit modeling tools — offer loans at several different interest rates. The better your credit, the lower the interest rate you qualify for.

Rates based on risk
“It makes more sense to price the loan according to the risk you’re taking on,” says David Kretz, a manager at
KPMG Consulting. “It allows you to give people with good credit a good rate and it allows you to give people with not-as-good credit an opportunity.”

Eighty percent of small lenders who participated in the annual Automobile Finance Study by the
Consumer Bankers Association used tiered pricing for new and used auto loans in 1999, compared with 40 percent in 1998.

As for credit unions, 2,798 credit unions offered risk-based pricing in 1999, compared with 1,578 credit unions in 1995, according to the
Credit Union National Association.

The reason more lenders are moving toward risk-based pricing and offering loans to people with less-than-pristine credit is simple.

“There’s money to be made,” says Jack Nerad, author of
The Complete Idiot’s Guide to Buying or Leasing a Car.

Industry experts say folks with less-than-perfect credit benefit the most from tiered-pricing.

“In a one-rate-fits-all environment, they may have been turned down flat,” Kretz says. “In a tiered environment, it means lenders have a greater capacity to lend deeper in the credit spectrum. And lenders can give high credit consumers more appropriate pricing as well.”

Mike Schenk, vice president of economics and statistics for CUNA, adds:

“It brings more people into the fold. It allows you to serve more people. In the past you had to turn people down. You’re able to offer credit to people who wouldn’t otherwise get it.”

A chance — or a trap
But some consumer experts are skeptical about the benefits of risk-based pricing.

“People say, ‘Good news, more people get credit.’ In the real world, any time there’s more variables at play, the consumer loses,” says Remar Sutton, president of the Consumer Task Force for Automotive Issues.

Sutton says while risk-based pricing should mean good things for consumers — that’s not always the case.

“Lenders have more information. They can imply that your credit is worse than it is,” Sutton says. “Many dealers will say you don’t have the credit when you do.”

Folks with dinged credit should be especially wary.

“A car dealer who’s really greedy will take a person with one blemish on their credit and really gouge them for the interest rate,” says Mark Eskeldson, an auto expert and author of
CarInfo.com, a consumer information and advocacy Web site

It’s not to say
every lender is out to bleed as much interest as possible out of
every loan customer, but it’s important to keep your guard up.

How to beat the system
The way to make risk-based pricing work for you rather than against you is to shop around for financing.

“My advice has always been shop, shop, shop,” Nerad says. “You’re never going to get as good deal as when you let several lenders compete for your business.”

Start with your bank or credit union. Credit unions, in particular, have some of the lowest interest rates around.

“The first place people should go is a credit union,” Eskeldson says. “It’s a nonprofit organization. They don’t have any incentive to gouge anyone. They want to make loans to their members.”

Your best bet is to have a financing deal from a bank or credit union lined up before you set foot on a dealer’s lot. Challenge the dealer to make you a better offer.

“The dealer says 10 percent is the best rate you can get. It might have been 8 percent at a bank, but they didn’t shop around,” Eskeldson says.

Don’t be afraid to visit more than one dealership.

Get your credit report before shopping
It’s also a good idea to get a copy of your credit report before you shop for a car.

“I don’t think a lot of people have a clear idea of their own credit history or how they might be rated from the outside,” Nerad says.

Bankrate.com explains how to get a copy of your credit report and how to improve your credit in its
credit basics section.

It may mean a little extra work, but sizing up your credit report may keep you from paying more for a ding on your credit than you have to.

“I would never sign a contract with a high interest rate without pulling my credit report and making sure I deserve it,” Eskeldson says. “There’s no excuse for people saying ‘Oh gee, I don’t how bad my credit report is. I better take this 18 percent rate.'”