Poor credit drives up rates
By Rick Popely
CHICAGO - A car shopper with a limited or spotty credit history should
forget about zero percent financing and brace for the possibility of
double-digit interest rates.
That is the reality facing buyers who have yet to demonstrate they can
pay off a major debt such as a car purchase.
Lenders view a lack of credit history as a risk and may say, "No,
thanks" to dishing out thousands of dollars to finance a vehicle. Or, they
may accept the risk and charge interest rates much higher than the
current national average of about 5.5 percent for new vehicles.
For some buyers, including many first-timers, the only option may be a
"subprime" lender who charges 15 percent or more.
"Frankly, they have them over a barrel. If they have a blemish on their
record or don't have much of a credit history, their desire for a
vehicle can overpower their good judgment," said Wayne Gawlik, manager of
Chestnut Credit Counseling Services, a nonprofit organization.
Before providing such a large amount of money, "lenders will want to
see the credit history for this person and decide whether they qualify
for prime or subprime rates," Gawlik said.
The cost difference between prime and subprime is substantial. A
$10,000 loan for three years at 15 percent costs about $45 more each month
and $1,600 more in total than the loan at 5.5 percent.
Every time a lender orders a credit report from one of the three major
credit rating bureaus, it signals that person plans to increase his
"And the credit bureaus may lower the person's rating as a result,"
A better approach is for consumers to obtain their credit report
themselves from one of the three major bureaus -- Trans Union, Equifax and
Experian -- which has no harmful effect on their ratings.
The reports include histories of current and past debts and a FICO
credit score, named for Fair Isaac Corp., the company that developed the
scoring system (www.myfico.com). FICO scores range from 300 to 850, and
higher is better.
Lenders base their decisions on those reports. Gawlik warns the
information can be inaccurate, so it pays to check before applying for a loan.
"Don't be in a hurry to buy a car at the first sign of spring if you
don't have a clue as to what your credit bureau report looks like," he
Recently, a credit report for one of his clients showed 22 bounced
checks, none of which was hers. The culprit had the same first and last
Seeing what's on the report provides a chance to clear up such
discrepancies and settle old debts, such as a small credit card or cell phone
contract a consumer may have neglected.
"With a credit card or cell phone agreement, you're signing a contract.
If you skip or miss a payment, when you go for a loan, that can take
you from 12 percent to 22 percent," Gawlik said.
Having no credit history turns off lenders because they don't know what
to expect, so Gawlik suggests applying for a low-limit credit card as a
Charge small amounts and pay them off promptly to establish a credit
record, he adds, but exercise restraint. Credit cards are easier to get
than auto loans, and Gawlik says they're easier to abuse.
One way banks limit the potential for such abuse is by offering secured
credit cards that require a cash deposit equal to the amount that can
Bank of America, for example, offers secured cards with charge limits
as low as $250. Brittany Pletz, a Bank of America manager, says
customers who compile a clean record with a secured card may qualify for an
unsecured card after one year.
Another way for the credit-challenged to obtain a loan is to get a
co-borrower with a strong credit history, such as a parent, to sign the
"You're using their credit history to get approved for a loan, but
they're also responsible for the loan," Pletz said, adding that if payments
are made on time the credit ratings of both co-signers benefit equally.
To determine who qualifies for a car loan and for how much at what
rate, lenders will look at a buyer's income, current debt and ability to
Gawlik advises that car payments, other installment loans and credit
cards combined should be no more than 15 percent of gross monthly income.
That assumes housing expenses are no more than 25 percent of gross
income, so together they are a maximum of 40 percent.
A better idea is to borrow less and pay it off sooner. Paying bills on
time makes it easier to get bigger loans and lower interest rates.
Another suggestion: If a high interest rate boosts a car payment to
budget-busting levels, postpone the vehicle purchase to build a larger
down payment. Gawlik says lenders view a bigger down payment as a lower
risk and may give a lower rate.
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