Understanding Automobile Finance Credit
Understanding Automobile Finance Credit is a very important part of your Wealth Consciousness Journey.
Note: Financing a car actually is a wealth deteriorating event. A car is a depreciating assets, and one of the cardinal rules of investing is “Never Leverage a Depreciating Asset”. Ideally all cars and trucks would be purchased with cash. However, in our journey to financial freedom, we may come across the need to finance an automobile. As such, automotive finance is important to understand. Another option would be to finance a car using a life insurance policy loan or a margin loans against securities, neither of which require a credit check. We would be happy to discuss these strategies as you become a client.
After an auto dealer takes your credit application for an automobile loan, they may submit the application to banks or other automotive finance lenders. They way these lenders look at an auto credit application is completely different than how they analyze other types of loan applications. Auto Lenders generally only look closely at 4 items in terms of your credit. If you are weak in any one of these areas, you need to be strong in the other 3. If you are weak in 2 or more, you will likely be declined or get offered a crazy high interest rate from a specialty lender. Do your best to make sure all 4 of these items are strong before applying for an automobile loan.
1) CREDIT SCORE
2) AUTO TRADELINE HISTORY
Auto lenders will generally look at a 3-credit bureau report and take the middle score. Or they may just rely on one score from TransUnion or Equifax. Some credit reporting companies have special scores just for automotive lending purposes. Each lender will have its own credit criteria and will roughly run along the lines of 620-650 as a minimum score, 680 preferred score, and 720 or better as best score. The higher your score, the better.
AUTO TRADELINE HISTORY
Auto Lenders want to know specifically how you have performed on auto loans in the past. How many cars or trucks have you financed previously? Were you ever late on payments? Did you default or have a repossession?
Lenders will also look at the purchase price and loan amounts of your automotive lending history. A rule of thumb is that it is difficult to get a loan for more than 60% above any of your past auto loan amounts. For example, if the highest loan amount you ever had previously was $20,000, then $32,000 is about the highest loan amount you may get approved for this time around ($20,000 x 160%). First time auto buyers may need to find a specialty program to get approved and start building up their history.
Auto Lenders really appreciate stable employment. Especially long term salaried (W-2) employment in industries likely to continue for well into the future, like medicine, engineering, or education. If you are self-employed, you may need to demonstrate a long and stable history of good earning ability that is likely to continue well into the future. You may be challenged here if you are a consultant, salesperson, contract worker, or primarily a 1099 income earner. Make sure that if you are self employed you create the structure and appearance of a legitimate business owner with proper tax documents, financial statements, etc. If you are self-employed, you would also be well advised to talk to your CPA first before taking on any auto financing. There may be ways to structure your financing that makes better tax sense.
Your employment also includes your income. The higher your monthly income relative to the monthly loan payment, the more desirable the application to lenders.
Auto Lenders may not admit to this, but they prefer to lend to people who own their home over renters. Especially people who own their home outright with no mortgage. Why? People who own a home have a more permanent address and they will likely be easier to find in case of default. When people own their home without a mortgage, it also means that there isn’t a priority mortgage loan ahead of the auto loan in case of a bankruptcy, estate settlement, or some such thing. You can certainly get an auto loan if you are a renter, but owning your home gives you a better chance. Owning your home with no mortgage gives the best.
Auto Lenders Will Evaluate the Auto Deal Itself
How much is the auto being purchased for relative to current book value?
How old is the auto? How many miles? Is the CarFax clean?
What is the make and model? Is this a minivan, work truck, or sports car?
How much cash are you putting as a down payment?
Is there a trade? Is the trade bringing positive or negative equity to the deal?
How long are the financing terms?
Any big positive / negative items in the deal itself may tip the scales one way or the other.