If you’re on a tight budget, monthly payments for a car loan or lease can take the wind out of your sails. There is a way to lower the amount spent on car payments and improve almost every aspect of your financial life at the same time: improve your credit score.
There is a direct link between your score and your monthly car payments. Having even a marginally healthier financial history can reduce those larger payments, and a better financial profile can help reduce your transportation expenses as well. It’s high time to learn a little more about your score and about how you can improve it.
Let’s say you have a credit score of 620. A score like that would generally increase the interest rate on your auto loan by about 1.6 percentage points above the rate of a person with a score of 760. If your buddy with a 760 has an interest rate of 3.9%, you’ll get a rate of about 5.5 %. Not much of a difference, right? Wrong! That “small” difference adds up dramatically over time on big-ticket items like your car, adding thousands of dollars to the sticker price of the item, and tagging all those extra dollars onto your monthly payments.
So much extra cash over a simple number? It may be hard to believe, and even more difficult to accept. The financial consequences of such a triviality might seem unfair; the positive counterpart to this arrangement is that you can lower your bills by improving your financial record.
The Fair Isaac Corporation (FICO) is responsible for compiling credit ratings (also known as FICO scores.) When you apply for a loan, potential lenders use these figures, along with the accompanying reports, to determine the likelihood that you’ll be able to repay your loan. You can obtain your report through three major bureaus: Transunion, Experian, and Equifax.
The information in these reports tells you a lot about your rating. You’ll see where the figure came from, and how you can potentially improve it. FICO determines your score based on five factors, each having a percentage effect on your total rating. Let’s look at these factors and see how you can use each one to improve your rating.
It goes without saying that your payment history has a significant impact on your rating. What is your history of making payments? Are your payments on time and in full? Do you neglect to make payments at all? They may seem negligible, but these details matter. For example, if you’re late on a payment, the length of time that payment has been overdue and the size of that overdue payment make a significant difference to your score.
So what do you do about this? First up, remember that any late payment will damage your rating to some degree. Cell phone bills, medical bills, child support payments and even overdue library fees could be handed over to a collections agency, which will hurt your scores! A lack of payments history will also have a negative impact. You may have no late payments, but having few or no accounts will lower your rating as well. It might sound counter-intuitive, but a person with 6 to 10 accounts will probably have a better score than a person trying to be sensible with just one or two accounts.
To improve your payment history, you need to pay all your outgoing statements as soon as possible and develop the habit of meeting your payments on time. If you ever forgot to pay a bill, or you simply couldn’t pay it, you need to take care of that lapse as soon as you can. If you receive a letter or get a phone call from a collections agency, respond immediately. You don’t have to fork out the bill right away, though. Always attempt to negotiate a lower payment, or if you intend to pay the amount in full, ask for a removal of the collection from your credit file. Be strategic about which ones you pay off first because accounts paid in full hurt your record less than negotiated, partial payments. You can also use some simple strategies. Never pay a utility bill in cash. Use your card to pay the bill, use your cash to pay off the card, and you just paid two bills on time, with a single chunk of money!
Most folks think the total amount you owe is the kicker, but it’s not. Your credit utilization ratio is what matters. What’s this? Well, “credit utilization” is a term for how much of your available credit you’re using. For example, a balance of $2,000 on a card with a $10,000 limit is a utilization ratio of 25%. Any ratio over 30% makes you look bad, while a ratio below 10% makes you smell like a financial rose garden.
Your plan of action should be to reduce your utilization ratio by paying down your cards and avoid taking on further expenses that you can’t afford. If you know you can practice discipline, you could call your credit card company and request a limit increase on your card. Increasing the limit lowers your utilization ratio without necessarily paying down your card in the process.
Keep in mind; your utilization ratio is an overall look at all your accounts. Applying for, and receiving a new card, adds more credit to your overall amount, therefore reducing your overall utilization ratio. You need to proceed with great caution on this option though. Using up this new card’s limit will bury you more deeply in debt, which is exactly what you’re trying to avoid.
The longer your history, the better your score, which can be tough for newbies. The only action you can take on improving this factor is to continue developing your history. Avoid closing accounts in good standing, and keep up with payments consistently.
Here’s a factor that’s not too well known. Whenever you open a new account or have your credit checked, it hurts your score! Thankfully, it’s only temporary damage. As mentioned above, opening new accounts can benefit your utilization ratio, but you’re going to take a temporary hit. That’s why you should balance this factor with the others. For example, only open new lines of credit when you have a good history and have been meeting your payments consistently.
There are many types of credit out there. There are secured loans like mortgages and car loans, and unsecured loans like credit cards and even retail accounts. The good news is that having several different types of accounts can improve your score in some cases. Now, don’t go crazy opening up as many lines of credit as possible, but it’s not a bad idea to look at how many types of credit you currently have, and consider adding another couple of safe options to your report.
Now that you understand the factors that determine your score, you are ready to take the actions needed to improve it. After all, improving your rating is going to help you out a lot when it comes to those monthly auto-loan bills. It won’t happen overnight, but if you make an honest, consistent effort, you’ll be reaping the benefits in no time, not just on your auto loan, but on every other type of credit as well.
If you’d like to take a look at your credit report, head on over to AnnualCreditReport.com and get your free, yearly report.