The Impact of Credit Scores on Car Loans

Credit scores help lenders decide whether or not to approve loan applications and determine what loan terms to offer. The score is generated by an algorithm using information from your credit reports, which summarise your borrowing history.

THE BASICS

Credit scores are designed to make decisions easier for lenders. Banks and finance companies want to know how much of a risk you might be to default (not make a payment) on your loan, so they look at your borrowing history for clues. For example, they want to know if you have borrowed money before and successfully repaid loans or if you recently have stopped making payments on several loans or agreements.

When you get a loan, lenders report your activity to credit reference agencies, and that information is compiled into credit reports. Reading through those reports is time-consuming and it can be easy to miss important details.

With credit scores, a computer program reads that same information and spits out a score which is a number lenders can use to evaluate how likely you are to repay that loan or finance agreement. Instead of spending 20 minutes digging through credit reports for each loan applicant, looking at a score gives lenders a quick and general idea of the applicant's credit-worthiness.

Credit scores also can be beneficial to borrowers. Lenders are less able to use subjective judgement when a score tells them most of what they need to know. Scores shouldn’t discriminate based on how you look or how you act.

CREDIT REPORTING

You have multiple credit scores. For every scoring model that’s been developed, you have at least one score. Most people refer to FICO credit scores (Fair, Isaac and Company), but you have a different FICO score for each of the three major credit bureaus: Equifax, Experian, and TransUnion. When talking about your credit, it’s important to understand specifically what type of score is being used.

Traditionally, the FICO score is the most popular score used for important loans, like home and auto loans. No matter what score you use, most models are looking for a way to predict how likely you are to pay your bills on time.

The FICO credit score looks at how much debt you have, how you’ve repaid in the past, and more. Scores range from 300 to 850 and are made up of the following components:

- 35% = payment history: have you missed payments or defaulted on loans?

- 30% = current debt: how much do you owe and are you maxed out?

- 15% = length of credit history: is credit new to you, or do you have a long history of borrowing and paying it back?

- 10% = new credit: have you applied for numerous loans in the recent past?

- 10% = types of credit: do you have a healthy mix of different types of debt: auto, home, credit cards and others?

Some people don’t have a history of borrowing because they're young or never rented a property, they've never taken out a loan before or had a credit card or for other reasons. For these types of loan applicants, “alternative” credit scores look at other sources of information for payment histories, such as utility bills, rent and more.

To find out more about your credit history please check out the following:

www.equifax.co.uk - free 7 day trial: great to get a idea of where you stack up, but chargeable after trial ends!

www.experian.co.uk - free score check for life. You may need to prove ID with driving licence or passport.

www.checkmyfile.com - free credit score tool advertised as most detailed. ID may be required.