How your credit score affects the cost to finance a car

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Although new car prices have moderated somewhat, financing a vehicle purchase has not been getting any cheaper.

With the Federal Reserve’s latest hike in interest rates – the sixth year this year – car loans are set to become even more expensive. The Fed’s move is having a ripple effect, causing rates to generally rise on a variety of consumer loans and lines of credit (and some savings accounts).

The average price of a new car is about $45,600, according to recent estimates from JD Power and LMC Automotive. That’s down from the July peak of $46,173.

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However, rising interest rates continue to push up the overall cost to consumers of financing their purchases. The average rate on car loans has increased from an average of 3.98% in March to 5.60% in October, according to Bank Rate.

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And depending on the buyer’s credit score, the rate could be in the double digits.

“On a car loan, the difference between good and bad credit could be the equivalent of a few hundred dollars a month,” said Ted Rossman, senior industry analyst at Bankrate.

Your credit score is one of many variables that are considered

The higher your credit score, the lower the interest rate you can qualify for.

This important three-digit number is usually between 300 and 850 and is used in all types of consumer credit decisions. Lenders usually use information such as your income and other monthly expenses.

A good score is usually over 670, a very good score is over 740 and scores over 800 are considered exceptional, according to credit reporting firm Experian. Scores under 670 are considered fair; anything below 580, poor.

How credit scores can help and hurt Americans

The difference in interest rate available across different credit scores can be staggering.

To illustrate: With a credit score in the 720-850 range, the average interest rate for a five-year, $45,000 car loan is just under 5.8%, according to the latest data from FICO. That equates to monthly payments of $865, and the amount of interest you would pay over the life of the loan is $6,890.

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Compare that to what someone whose credit score fell between 660 and 689 would pay. That same loan would have an average rate of nearly 9.4% ($45,000 for five years), with monthly payments of $942 and $11,514 in interest over the life of the loan as a result. (See the chart below for other credit scores.)

While it’s difficult to know which credit score a lender will use — they have options — the general goal of avoiding dings on your credit report helps your score, regardless of the specific one used, experts say.

“Many credit-building tips are more of a marathon than a sprint: Pay your bills on time, keep your debt low and show that you can successfully manage different types of credit over time,” Rossman said.

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“That said, there are a few things you can do to improve your score quickly,” he said.

Tip: Lower your credit utilization

His best tip? Lower your credit utilization ratio. “This is the amount of credit you’re using on your credit cards divided by your credit limits,” Rossman said.

He said even if you pay your balances every month, the credit reporting firms — Experian, Equifax and TransUnion — often get balance data before you pay it.

“It’s usually reported on your statement date, so consider making an extra mid-month payment and/or asking for a higher credit limit to lower your ratio,” Rossman said.

Check for mistakes on your credit report

Additionally, he said make sure there are no errors on your credit report.

To check for mistakes and understand what lenders would see if they pulled your credit report, you can get a free copy from each of the three major credit reporting firms. These reports will be available for free on a weekly basis before the end of next year.

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