CONSUMER CREDIT It pays to shop for a loan before picking out a car
Consumers should obtain their credit report directly from a bureau.
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, their 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 with offices in the Chicago area and downstate Illinois.
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 sub-prime 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.
Shopping for a loan before shopping for a vehicle helps consumers gauge their credit standing, but applying to several lenders carries a risk, Gawlik said.
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 debt.
"And the credit bureaus may lower the person's rating as a result," Gawlik said.
Obtaining a report
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 rating. All three have Internet sites (transunion.com, equifax.com, experian.com) and charge $10 to $15 for a report.
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 said.
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 names.
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 first step.
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 be charged.
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 contract.
"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 pay.
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 and paying back a loan early make 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.