The Impact of Credit on Auto Financing (2024)

Everywhere you turn, there’s talk of how to raise your credit score. But what exactly does a higher credit score mean for your bottom line? Turns out it can mean a lot.

Generally speaking, the higher your credit score, the better terms you can get when financing an auto. The biggest potential benefit is a lower interest rate, which means you’ll be paying less in interest over the life of the auto financing contract. Because your rate is lower, your monthly payment will also be lower. That’s money you could sock away in savings, or if you wanted to splurge, upgrade to your dream car.

People often want to know what a “good” credit score is and what finance companies are looking for. There are various sources for credit scores that finance companies use to evaluate applications, and they don’t always correspond to the score you can get from your credit card company. So don’t be surprised if a company gives you a different number than what you thought your credit score was. Scores can differ from one credit reporting service to another and even from one day to the next.

Experian publishes a list of average interest rates for each of five credit categories:

Source: Experian State of the Automotive Finance Market Q4 2023

As anyone who has ever financed anything knows, interest rates change daily, so the above chart is a snapshot in time and current rates will differ. But it gives you a picture of how credit scores have a dramatic impact on the rate you’re offered by a finance company.

When making credit decisions, auto finance companies also consider factors such as:

• Monthly income
• Debt-to-income ratio
• On-time payment history
• In some cases, two years of credit history

Of those criteria, on-time payment history is probably the best indicator to a potential finance company of the risk they’re taking in approving credit for you. If you have a history of making payments on time, finance companies figure your chance of defaulting on the contract is lower. On-time payments are also the fastest way to improve your credit score.

Not-so-great credit

All well and good, but what if your credit isn’t the best? You can get auto financing with almost any credit score. But as you can see from the chart above, the lower your credit score, the more you’ll pay for financing.

One option, especially if you’re just starting to establish credit, is to have a co-signer. That person shares responsibility for the loan and, if they have a better credit score, that could help get you a better rate.

Dealerships want to get you into a car. And some may have relationships with finance companies that specialize in helping people with lower credit scores.

Get your credit in shape

If you don’t have to buy a car immediately, and have some time to work on your credit, your best strategy is to raise your credit score. These steps will help you do that:

• Make payments on time. Even if you can’t pay the full amount, contact your creditor to see if you can make a partial payment. That shows them you’re trying, and it’s better to make a partial payment on time than to skip a payment altogether.
• Check your credit report with all three reporting bureaus — Experian, Equifax and TransUnion — for errors. If you see something that doesn’t look like a purchase you made, dispute the item with the bureau and get it straightened out. You don’t want a potential finance company accessing incorrect information. You’re entitled to a free credit report every year.
• Keep your balances on credit cards low, relative to the credit limit. Auto finance companies like to know that you don’t overspend, even if you have the ability to buy more.
• Resist opening credit that you don’t need. Don’t succumb to all those credit card offers unless they can really help you, such as transferring a high interest balance to a card with a lower interest rate.

Preparing to apply

When you’re ready to apply for auto financing, many finance companies have calculators that allow you to prequalify and get an idea of what your terms might be without a hard hit to your credit report. But when you fill out the actual credit application, limit those to your top companies because those will result in a hard pull on your credit report, which could temporarily dip your score.

Save for a down payment. The more you can apply in a down payment or trade in, the smaller the amount you’ll need to finance, lowering the interest you’ll pay over time. Make the length of the loan the shortest you can within the amount you can afford in a monthly payment. That will get your auto paid off sooner and again, lessen the interest you’ll end up paying.

Before you apply, unfreeze all your credit reports. (You can freeze and unfreeze your reports with all three bureaus online.) Auto finance companies probably won’t look at all of them, but they will examine at least one, and they can’t get the information they need if they’re frozen. (It’s a good practice to freeze your reports any other time because it makes it much harder for bad actors to open an account using your identity.)

After you’re approved

If you can afford it, make more than the required monthly payment — an additional principal-only payment. Not only will it help you pay back your contract sooner, it will also save you in interest.

Remember, credit isn’t a bad thing. If you manage your credit well, you’ll pay a lot less interest on auto financing and, consequently, for your next vehicle.

Still want to learn more? Check out other auto financing resources, simple interest facts and more.