This week we’re continuing to learn about credit histories, credit scores, and how all this fits into learning how to buy a car and getting a car loan.
Your Credit Score
Many years ago, way back in 1956, a little firm came into existence called Fair, Isaac and Company. These guys were number crunchers who, two years later, developed the first consumer credit scoring system.
The company and the credit score they invented came to be known as FICO®. This is the gold standard credit score and the one used by millions of creditors nationwide.
The FICO score ranges from 300 – 850, with 850 being perfect credit and 300 being, well, pretty much the worst possible credit.
How does FICO come up with this score? They use consumer information from the credit bureaus, and since there are three different bureaus each with potentially different information, there are three separate FICO scores.
In general, though, there are just five components to your credit score, and they are each weighted differently. Here’s a breakdown:
35% Payment History – How are you at paying your bills? Are they paid on time and paid in full?
30% Amount You Owe – How much money do you owe? Also, how much money is available on your credit accounts? For example, do you owe $300 on a credit card with a limit of $5,000?
15% Length of Credit History – How old are your credit accounts? When is the last time you used them?
10% Credit Mix – What different types of credit do you have, such as loans, credit cards, etc.? A good mix is important.
10% New Credit – Do you have lots of recent credit inquiries on your report, or several newly opened lines of credit?
FICO also has several different types of scores, depending on what type of credit you’re applying for. There’s even one called the Auto Enhanced Credit Score that is specifically for car loans, although you as a consumer don’t have access to it – it’s only for auto finance professionals.
And to complicate matters further, there are other credit scoring companies out there. The three credit bureaus have their own score called the VantageScore, which is meant to compete with the FICO score.
Other consumer credit companies have attempted to put together their own approximations of credit scores, although it’s important to note that unless they are FICO or Vantage scores, they are not likely to be used by creditors. They might be fair approximations but you’re best off getting your FICO score if you want to be accurate.
Prime… Subprime… Super Prime… What Does All This Mean?
You might hear these terms when people talk about credit and lending. Putting strict definitions on them is something else entirely. Different lenders and even the credit bureaus themselves don’t necessarily use the same credit score ranges for these labels.
You can use the following FICO ranges as a guideline:
300 – 549 Deep Subprime
550 – 639 Subprime
640 – 679 Fair-to-Good
680 – 739 Prime
740 – 850 Super Prime
Of course the labels themselves have little actual meaning, in terms of how it affects you as a borrower. Your own score and credit history will have the most affect. Speaking of which…
How Does My Credit Affect Me?
Well, as noted before, your credit history and score provide creditors a way to assess the risk of giving you credit. The lower the risk, the happier they are to give you money.
Creditors and lenders who give car loans show their happiness by offering favorable terms. That generally means lower interest rates and maybe no down payment requirement.
But if they think you are higher risk, you’ll see higher interest rates or even get turned down for your loan.
The good news, at least as far as car loans go, is that poor credit is not an automatic disqualification. Car loans are available to more people with troubled credit histories than any time before. But it could cost you.
myFICO.com has a really neat Loan Savings Calculator that includes average interest rates for various credit score ranges. Let’s look at how your score impacts things. We’ll use a 48-month, $20,000 used car loan for our example:
Credit Score: 615
Interest Rate: 15.10%
Monthly Payment: $558
Total Interest Paid: $6,765
Okay, that’s where you are if you’re in the subprime range. Let’s see what happens if you can get your credit score up into the fair-to-good range:
Credit Score: 660
Interest Rate: 7.60%
Monthly Payment: $485
Total Interest Paid: $3,256
WOW. That’s a big difference. Your interest rate is essentially cut in half. Your payment goes down $70 every month. And that means you pay $3,509 less in interest over the life of the loan.
Needless to say, having a decent credit score can put a lot of money in your pocket.
So next week we’ll discuss some strategies to establish credit or move your credit score in the right direction.