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Auto loans and credit scores: a perfect (or lethal) combination

[Oct 24, 2011.]


FICO, the company that devised the most widely used credit scoring system, provides on its website a good explanation of why your credit report is so important when you're negotiating auto loans. It says:

Your FICO score is a representation of your risk to the auto lender. So, a good FICO score means you're less risky of a borrower and can be offered a lower interest rate. A bad score may mean you won't qualify for the auto loan, or if you do, you will likely be offered a higher interest rate.

Most people know that, but it's when you translate the bland words into hard cash terms that their real meaning sinks in. Luckily, the company has a nifty auto loans calculator on its website that does precisely that.

Cheap loans--if you qualify

Suppose you want a $5,000, 48-month loan to buy a used car. FICO's calculator says* that, if you have great credit (in the 720-850 range), you may qualify for an annual percentage rate (APR) as low as 5.41 percent. That would mean monthly payments of $116, and the total amount of interest you'd pay would be just $572.

But suppose your credit score is in a middle range, say 620-659. Then you could find yourself with an APR of 14.985 percent. Your monthly payments would be $139, and your total interest a significantly more painful $1,678.

Thinks that's bad? If your credit score is in the basement (500-589), your APR could be 20.391 percent, your payments $153 a month, and your total interest charges an eye-watering $2,353. Yep, those with terrible credit can expect to pay more than three times as much in interest on their auto loans as the most creditworthy.

Helping yourself to cheap auto loans

The Federal Trade Commission suggests a number of ways in which you may be able to improve your credit score quickly. There are no guarantees, but the following steps may be helpful:

  1. Avoid credit repair scams. They're often expensive and useless.

  2. Get hold of a copy of your credit report. You're entitled to a free one each year from annualcreditreport.com.

  3. Check it carefully for errors.

  4. If there are any (and many contain them), have them corrected.

  5. If there are accurate negatives, clear those up (at least, the ones you can afford to pay off) before you apply for more credit. At least try to sort out the small ones.

  6. Be upfront with any prospective lender about remaining problems, and give persuasive explanations for how they arose.

Good luck. And remember, shop around for quotes for auto loans before you commit yourself to any deal.

* National average figures;you can set the calculator for your state.


About Author:

Peter Andrew has been writing about -- and for -- business for more than two decades. For the last couple of years, he has found himself increasingly specializing in the U.S. financial sector.

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