How Your Credit Score Can Impact Your Car Loan Approval And Interest Rate
Ketki Jadhav
Jun 26, 2023 / Reading Time: Approx. 4.5 mins
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Interest rate is one of the most influential factors when seeking a car loan. To secure a favourable car loan interest rate, having a solid credit score is beneficial. By exploring various lenders for the most competitive rates and monitoring your credit score, you can save a significant amount of money on your loan throughout its duration. This article helps you understand the influence of your credit score on car loan approval and interest rates.
A credit score is a numerical value, ranging from 300 to 900, that reflects an individual's ability to repay loans. When banks and NBFCs assess loan applications, the credit score plays a significant role as it provides lenders with an indication of the borrower's creditworthiness. Among various factors considered by lenders, credit score holds the utmost importance. A higher credit score attracts more interest from banks and NBFCs, indicating a lower likelihood of defaulting on a loan. Thus, a higher credit score greatly enhances the chances of loan approval, while a lower credit score lowers the chances of getting a loan.
Having a favourable credit score not only increases the likelihood of getting approved for a car loan but also provides access to exclusive benefits. These benefits can encompass enticing offers such as 100% car financing, which means zero down payment requirements, reduced processing fees compared to standard rates, special lower interest rates, and more.
Here Is How a Good Credit Score Can Help You Avail of a Car Loan:
Loan Approval
Loan approval is influenced by various factors, including credit score. To determine if you meet the lender's criteria for a car loan, you can use car loan eligibility calculators that are easily available on various financial websites. While the credit score serves as an indication of your creditworthiness, a favourable rating facilitates smooth and prompt loan approval. However, borrowers with credit scores ranging between 600 and 750 may encounter some challenges in obtaining loan approval, depending on other contributing factors.
Interest Rate
The credit score also affects the interest rate for a car loan. A higher credit rating signifies creditworthiness and a lower risk of default for the lender. Lenders charge interest to offset for the risk involved in granting a loan and for the opportunity cost of utilising the funds. A good credit rating translates to lower risk, enabling you to secure a loan at a lower interest rate compared to someone with a lower rating.
Loan Amount
When purchasing a car, it is usually necessary to make a down payment, and the remaining amount can be obtained as a loan. A lower credit score limits the loan amount you can access, which requires you to contribute more from your own pocket. In such cases, you might need to dip into your savings or postpone your car purchase until you accumulate enough for the down payment. Applicants with healthy credit scores are preferred over those with lower scores, as banks or NBFCs are more likely to offer them larger loan amounts. Using a car loan calculator can assist in determining the eligible loan amount.
Wider Choice of Lenders
A low credit score narrows down your options when it comes to lenders. Only a few banks are willing to extend loans to individuals with low credit ratings. On the other hand, a good credit score provides you with more choices and the ability to approach lenders who offer favourable terms, such as low processing fees, longer loan tenures, higher loan-to-value (LTV) ratios, and competitive interest rates.
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What Is Considered a Good Credit Score for a Car Loan?
The four major credit bureaus, namely TransUnion CIBIL, Experian, CRIF High Mark, and Equifax, use slightly different scoring models. However, a credit score above 700-750 is generally considered good.
Here's how your credit score, or CIBIL score, can impact your loan approval:
A credit score between 750 - 900:
There are high chances of your car loan request approval. Moreover, you may also have the opportunity to negotiate favourable interest rates and loan amounts.
A credit score between 600 - 749:
With average or moderate scores, you can still get approval for a car loan. However, lenders will scrutinise other factors such as income, existing loans, employment stability, etc. Consequently, the approval process may take longer, and you may not secure the most competitive interest rates.
A credit score between 300 - 599
Scores below 600 will significantly reduce your chances of approval for a car loan, and you may face rejection. However, if you receive loan offers, they may come with lower loan amounts, higher interest rates, or requests for collateral such as assets or fixed deposits.
Can You Get a Car Loan with a Low Credit Score?
While having a favourable credit score increases the likelihood of car loan approval, having a comparatively lower credit score or no credit history does not automatically disqualify you from obtaining a car loan. Take note that no credit history (denoted as NH/NA on a credit report) typically indicates a lack of previous loan or credit card usage. In such cases, lenders consider the following factors to assess your eligibility for a car loan:
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Income: Demonstrating a stable source of income that can support monthly loan instalments improves your chances of approval. Income proof documents such as salary slips, Form 16, profit, and loss statements, etc., need to be submitted to the lender.
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Loan Amount: A lower credit score suggests a higher risk of loan default compared to applicants with higher scores. As a result, you may choose to request a lower car loan amount and opt for a higher down payment to increase your chances of loan approval.
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Co-applicant/Guarantor: Applying with a co-applicant who possesses a better credit score and a stable source of income can enhance your eligibility. Alternatively, you may consider securing a guarantor who can provide the lender with an additional layer of trust regarding both your repayment capability and the guarantor's financial stability.
How to Improve Your Credit Score for a Car Loan?
Given that a low credit score can hinder your chances of getting a loan from banks, here are several methods to improve your credit score:
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Be aware of your current credit score;
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Thoroughly examine your credit report for any inaccuracies or errors and promptly address and rectify them;
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Settle any overdue or defaulted payments as soon as possible to improve your credit standing;
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Ensure that you make timely payments on your credit bills and EMIs (Equated Monthly Instalments);
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Avoid utilising more than 30% of your available credit limit, as higher credit utilisation can negatively impact your credit score;
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Refrain from making numerous credit requests within a short period, as this can negatively affect your creditworthiness.
Take note that improving your credit score is not an instant process, and there are no quick fixes. It will require time and effort to rectify, but you should start noticing improvements within a few months.
Conclusion:
Your credit score plays a crucial role in determining both the approval of your car loan and its interest rates. A good credit score opens doors to favourable loan terms, including higher chances of approval, quicker processing, lower interest rates, and larger loan amounts. On the other hand, a lower credit score poses challenges, requiring lenders to scrutinise additional factors and potentially resulting in longer approval processes, higher interest rates, and smaller loan amounts. It is essential to be proactive in improving your credit score by responsibly managing your finances, making timely payments, and minimising credit utilisation. By understanding the impact of credit scores on car loan approval and interest rates, you can take the necessary steps to enhance your creditworthiness and secure suitable loan terms for your car purchase.
KETKI JADHAV is a Content Writer at PersonalFN since August 2021. She is an MBA (Finance) and has over seven years of experience in Retail Banking. Ketki specialises in covering articles around banking, insurance, personal finance, and mutual funds and has been doing it for over three years now.
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Disclaimer: This article is for information purposes only and is not meant to influence your investment decisions. It should not be treated as a mutual fund recommendation or advice to make an investment decision.