How Buying a Car Can Lower Your Credit Score
The end-of-year car sales are upon us and while the deals are usually really good during this time of year, you should also consider how buying a new car could affect your credit. Specifically, how it could affect, or lower, your credit score.
Your FICO credit score is calculated by a complex algorithm that involves a large list of different things that either positively or negatively affect your credit score. Right now, though, we just want to focus on how a car purchase can affect or score. I’d like to focus on how it could potentially lower your credit score.
The Credit Check
Unless you’re purchasing the vehicle with cash – in which case it wouldn’t have any affect on your score – the first step in the purchase process would be to qualify for a car loan. The process of qualification includes a credit check. If you have already had your credit run several times that same year, having it checked again could negatively impact your score. This can be extra dangerous if your credit score is low, as you may have to apply with several different lenders before getting approved. If that is the case, your credit will be run several times, lowering your score even further.
The next area that could negatively affect your score is the debt-to-income ratio. One of the pieces in the FICO score puzzle is looking at how much debt you have versus how much your income is. If you already have a lot of debt – such as a mortgage, student loans, credit cards, doctor bills, etc. – then by increasing that debt by adding a car loan, especially if it’s a large amount, can seriously impact your credit and lower your score.
On the flip side, someone with no debt but poor credit – such as someone who recently went through bankruptcy – could actually improve their credit score by purchasing a new car. By adding some debt and making regular payments, it helps show they’re financial stable and adds positive credit history.
Lastly, you want to consider the monthly payments. While you definitely don’t want to get a payment plan that is more than 5 years, if you have poor credit and your interest rate is high, your monthly payments could also be high. The last thing you want to do is accept a monthly payment that you can “get by” with. Always remember that cars have expenses outside of monthly payments – such as oil changes, new tires, maintenance, battery replacements, etc. – which could cause financial problems down the road.
When purchasing a new vehicle, make sure that you can easily make the monthly payments to avoid the possibility of dealing with late payments. Late payments can seriously damage your credit and lower your score. Many people have the tendency to purchase a vehicle with monthly payments that seem reasonable but seldom consider the instances where things don’t go as planned. Make sure that you can easily make the monthly payments, with room to spare.
A big factor in the monthly payment is going to come down to the interest rate. That is largely affected by your credit score. If you have a low credit score, then your interest rate will be high and that will increase your monthly payments significantly. If it’s going to be tight, your best bet is to focus on improving your credit score first, before buying a new car.
For more financial advice or assistance with credit repair, contact Credit Absolute for a free consultation.