As Benjamin Franklin put it: “By failing to prepare – you are preparing for a failure“.
Educating yourself about car loans doesn’t just make sense – it makes Dollars! Financing is one of the areas where car dealers can use all kinds of tricks to make you think you are getting a better deal than you are.
Remember that the car dealer is actually selling you two different products. Besides buying a car you also buy a financing product. It’s not unheard of dealers willing to sell you a car at their buying cost because they’re making a killing on the financing plan!
Prepare Your Credit
If I had to choose a single tip from this website – This would be it. Two or three month BEFORE you plan to start shopping around for terms, start paying your credit card purchase before statement date. This will force the credit card companies to report a low balance to the credit bureaus. The low balance will boost your credit score and will also lower your debt-to-income ratio – a major factor for setting your terms.
Shop Around For Best Terms
When you’re shopping around for auto loans, you want to get the best rates – and you should. A common misconception amongst car buyers is that they are afraid to shop for better rates because they’re afraid that it will lower their credit score and eventually get them lesser terms.
Fortunately, Fair Isaac (the creator of Fico score formula) acknowledges the importance of rate shopping, so it introduced the following 2 exceptions into the Fico formula:
- Fico score ignores auto loan inquiries made in the 30 days prior to scoring. This means that any inquiries made by lenders while you’re in the process of rate shopping – have no effect on your credit score and on the terms offered to you.
- All car loan inquiries made during the defined rate-shopping period (45 days in the new Fico formula or 14 in the old one) will be counted as a single inquiry. This means that even after you’ve finished your rate shopping, your score will not plummet because of multiple inquiries.
Check Your Credit Reports
It’s imperative that you know what your credit reports look like, and even better – what are your credit scores. Remember that almost all auto dealers and financiers buy your credit information from just one credit bureau.
Which one? You can never tell. This is why you need to make sure that all of your credit reports from all 3 major credit bureaus are clean. If they are not – do go the extra mile and spend the time and energy to clean any bad/incomplete/inaccurate information that you can. A clean credit report and a better score that follows can mean the difference between getting the kind of financing that you need, and paying hundreds of dollars in extra interest payments.
Another benefit of having your credit reports before you start shopping for a car is that you can arrange financing ahead of time (see more about this below).
Which Credit Bureau Are They Using?
While most dealers will run your reports at one of the 3 major credit bureaus (Experian, Equifax & TransUnion), some prefer to use other credit reporting agencies. These no-name credit bureaus use proprietary credit scores of their own, and have very few businesses reporting to them. As a result, your score tend to be lower at these bureaus than what it is at the three major ones. Furthermore – you have no way of getting your hands on your score or report from these bureaus.
My advice – simply go to a different dealer!
What Credit Score Are They Using?
While most dealers will run your Fico score, about 30% of car dealers use a special credit score called “Fico Auto Industry Option Score” or “Auto Enhanced”. This score is similar to Fico, but puts more emphasis on previous car loans you had. Its score tends to be lower than your Fico score, and very low in case that it’s the first time you apply for a car loan (because you have no car loan history on your report).
You can’t pull this type of score yourself from the credit bureaus, so you have no way of verifying the information your car dealer sees.
Some of dealers go even further, and will refuse to lend you money for a car if you have no past car loans.
If you run into trouble with such dealer – simply move on to a different one that uses Fico.
Credit Score Isn’t Everything
Remember that credit reports and score are only part of the lending decision. Other factors such as income level, debt-to-income ratio, employment stability, other assets and more can have bigger impact than your credit score.
You need to know what kind of financing you can get with your credit history (good or bad) BEFORE you visit the car dealer. Also, if you obtain a credit report before starting the car shopping process, you can arrange financing ahead of time.
Many lenders will pre-approve car buyers for certain loans based on the information that’s on their credit reports. This can help you to better understand how much you can afford, and even better – you can leverage the pre-approved financing deal against the loan offered by the dealer to improve your terms.
The “Bad Credit” Scam
It’s not unheard of car dealers who simply lie to customers about their credit score. They hand them a phony “credit score” check with a very low credit score, arguing that they can’t get the promotional APR and can only get a much higher one with that kind of score. They stand no chance if you came prepared and know your credit scores.
Low APR Car Loans
Almost all car dealers and auto manufacturers post promotional low/0% APR loans in order to get you through the door.
Unless you have stellar credit reports and scores, chances are you won’t qualify. Statistic shows that less than 7% of car buyers do. You will need a clean credit report and a 720+ credit score.
Many 0% APR loans offer only 36 monthly payments plan, something many buyers cannot afford because of the high monthly payments associated, and are therefore forced to pass off the deal.
Extended Length Loans
Many car dealers like to extend the length of the loans in order to get the monthly payments down. This allows them to hide a high APR or not-so-attractive car price.
My advice is to avoid these loans. They may seem attractive, but you end up paying much more on interest than you bargained for. For me – it’s a sure sign that I’m aiming too high and I’m better off with a cheaper or pre-owned car.
Required Credit Score for Auto Loan
If your credit score is below 680, expect to get lesser terms (See this table). If your credit score is below 600, you will experience difficulties getting approved. If you do – the offered APR will be high.
Manufacturer’s Rebate vs. Low APR
Some manufacturers offer a rebate if you’re willing to finance the car through them. This offer is almost always good for you and can actually save you $1,000 – $2,000 on the total cost.
If you get such offer – take it. Once you have the rebate – consider refinancing with an online lender and save even more. It’s almost always worth it, even if there is an early payoff penalty.
Alternatives to the Dealer’s Financing
According to the Consumer Federation of America (CFA), car buyers are often overcharged by 3% on their loans at the dealership, which can add more than $1,000 over the life of an average car loan.
In most cases you can get better terms at one of the many online third party financing sites. Online loan rates are usually lower than car dealers. In addition, there here are no applications fees or hidden fees associated and approval is very quick.
Credit unions are also better option than car dealers. You can get favorable rates than your local car dealer, and the approval process is very quick, usually over the phone!
How to beat car dealers at their own game?
You can use this information to your advantage when you buy a car. Here’s what you need to do:
- Get your three Classic FICO scores from myFico (actually, nowadays you can only buy two – Equifax & TransUnion. Experian is no longer available).
- You have the upper hand over the loan officer, because you know how you’ve handled your prior car loan(s). If you handled them good, your Auto-Enhanced Fico Scores will be higher than your Classic Fico, so you can expect more from the lender.
- If you handled your prior car loans badly and expect your Auto-Enhanced Fico Scores to be lower than your Classic Fico, simply try to find an auto lender that uses just the Classic Fico scores, where you’ll have your best chance of getting the lowest interest rate.
- When you first walk into the finance director’s office, don’t tell him what your FICO scores are. Wait until he reviews the scores himself. Then ask him what your scores are.
- If the scores he reviewed are higher than the ones you have, don’t say anything and just go by his scores.
- However, if your scores are higher, then pull them out and show him. If he has a choice in the type of scores he can use, there’s a possibility that he’ll be able to use your highest score. He will also know that you’re not a fool and that he can’t take advantage of you!
- Ask the lender to show you their tier levels. Tiers are basically charts lenders use that have different interest rates based on your scores. You want to see which tier your fall in. If they won’t show you, have them break it down for you verbally.
How to select a car dealer?
If you have prior auto-loan related negative information of your credit report, then you simply need to find a dealer that uses just Classic FICO scores, or one that can choose what score to use.
Call each dealership and ask the finance person the following:
- What credit reporting agency do they use?
- Are they using FICO Auto Industry Option scores (or you can say, “FICO Auto-Enhanced Scores”), Classic FICO Scores, or both?
- Can they choose what score to use in the lending decision?
- What’s the minimum score you’ll need to get approved through your captive lender?
- What’s the minimum score you’ll need to get approved at the best rate by your captive lender?
- If you do have a major negative item on your credit report such as discharged bankruptcy, lien, or collection – ask them how these affect your loan decision?
- What factors other than your credit scores go into the lending decision?