As a first-time buyer, you’ll want the highest possible credit score to help you obtain the lowest possible interest rate on your car loan! But exactly how do you go about polishing (or establishing) your credit? Let’s dive in.
- A higher credit score can help you secure a car loan with a lower APR, so that you pay less interest over time.
- Several factors — including credit card utilization, payment history, and credit history — can affect your score in a positive or negative way.
- There are several things you can do to improve or build your credit, including paying your bills on time and reducing your outstanding credit card debt.
Your Credit Score: Why It Matters
Your credit score or FICO score gives lenders a good idea of whether or not you’ll repay your loan. The higher the score, the less of a risk you pose. As a lower risk, you can score a loan with a lower APR. And that means you’ll pay less interest than you would with a low credit score. Although you can still take out a car loan with little or no credit, you’ll end up paying a higher rate.
Factors that Make or Break Your Score
What exactly goes into your credit score? Several factors come together to make your total score: payment history, credit card utilization, credit history, new accounts, and different types of credit. As we’ll see, each factor is weighed a little differently.
The biggest factor is payment history, which makes up 35 percent of your score. Paying your bills on time (or not) will have a dramatic effect on your score.
Next up is your credit card utilization ratio, which makes up 30 percent of your score. What’s your credit card utilization ratio, you ask? Simple — it’s the amount you owe versus your credit limit. Keeping your credit cards at or under around 30 percent of their spending limits will boost your overall credit score.
The length of your credit history is the next-biggest factor, contributing to 15 percent of your score. The longer your credit history, the better.
Opening new accounts will also affect your score, contributing to about 10 percent of your score. If you open too many new accounts at once, it can take a negative toll on your score.
Finally, you can help your score by opening different lines of credit, a factor that represents 10 percent of your score. Different types of credit include major credit cards, conventional loans, and retail accounts.
How to Establish Credit
If you’ve got time before you need to take out a car loan, you can establish your credit by taking out a credit card. Make payments in a timely fashion and keep your overall credit utilization around (or under) 30 percent to improve your credit score.
Taking out a car loan can also help you establish a credit record. If you have absolutely no credit, you can use a cosigner (such as a close relative with a great credit score) to help you secure a better interest rate. If you have trouble finding a low APR, you can always obtain a bad credit loan and refinance your car at a later date, after you’ve established good credit.
Tips for Building Your Credit
Since you want the lowest possible APR on your new car loan, you also want the highest possible credit score. Here are a few tips that can help you build or repair your credit.
Pay Your Bills in a Timely Fashion
Paying your credit card and loan payments on time will help keep your credit score on the up and up. Even if you’ve had to make late payments in the past, paying your debts on time in the future will help you rebuild your credit over time.
Reduce Your Credit Card Debt
Debt is one of the biggest factors affecting your credit score. If you’ve maxed out your credit cards, it’s going to show in your score. Reduce your credit utilization — or the percent of your available credit limits you’re using — to improve your FICO score. With your credit utilization around (or below) 30 percent, you can typically qualify for a lower APR on your car loan.
Don’t Open New Accounts
When you apply for a new credit card, the subsequent inquiry into your credit can negatively affect your credit score. Especially when you’re about to apply for a car loan, you’ll want to avoid even a small hit to your score.
Check Your Credit Report for Errors
Every year, you can obtain a free copy of your credit report from AnnualCreditReport.com. Carefully review yours to make sure it doesn’t include any errors that might be weighing down your score, such as a missed payment you didn’t actually miss.
If you find any errors, notify one of the major credit bureaus (Equifax, Experian, or TransUnion) of your dispute via mail. The credit bureau will attempt to verify the disputed information. If they can’t verify it, they’ll remove it from your credit report.