Getting into financial shape before a car purchase is a bit like training for a marathon. Either will be tough on you if you aren't in good condition to begin with. But if you limp to the finish line at your financial institution, you will end up losing much more than bragging rights among your couch potato friends. You will lose money.
Many people can increase their credit score in the final months before their car purchase and reap a better interest rate as a result. This is true even if -- or perhaps especially if -- your credit is less than sterling. Many lenders classify borrowers into tiers, so you can improve your credit profile and interest rate just by edging into a higher category.
For example, you might be able to trim a couple points off your rate by moving from sub-prime (often considered a so-called FICO score of 620 or less) to near-prime (620 to 680) or to prime (680 or above).
Many borrowers know they can improve their credit score by paying their bills on time for an extended period, even if there were lapses in the past. But fewer may realize that their score will worsen if they close down accounts in an effort to tidy up their finances. (The reason: this eliminates a source of funds they could tap into an emergency.) This is especially true if they close down old accounts that suggest long-term stability to lenders.
Of course, you can't overcome years of inattention and work miracles in five or six months. But lenders pay attention to some unusual factors that buyers might not normally think about, and credit experts have come up with some special strategies to deal with them. Here are five.Step One
Check your credit score and record at least three months ahead of your planned purchase -- and do it in a way that doesn't expose you to unnecessary charges and scams, says Gail Cunningham, spokeswoman for the National Foundation for Credit Counseling. She warns against the dozens of bogus sites "that try to get you to enter your personal data, and then of course they have stolen your identity."
To play it safe, she recommends that you check with www.annualcreditreport.com, an authoritative website for the industry. Consumers can check credit reports from each of the three major bureaus once a year at no charge. Once you have your report, you can pay any bills you may have missed and correct any errors. The credit report will come with a form that you can use to challenge its contents in case of mistakes. Then Cunningham suggests that prospective car buyers go to www.myfico.com to get their score for a low fee.
In two to three months, credit records should reflect any corrections and any bills that were belatedly paid. That, in turn, will tend to raise a credit score, which may yield a lower interest rate.Step Two
Try not to trigger credit checks related to insurance policies or employment applications before you apply for a car loan.
Even though they aren't related to loan applications, ratings agencies may take a flurry of inquiries from employers or other institutions as a sign that you urgently need cash, even if they aren't coming from loan applications. They invariably take a dim view of anything resembling the wanton pursuit of credit.
"The more inquiries on your credit report, the more it's going to appear that you are desperate and that you are trying to rack up debt," says Lea Anne Broseus, consumer lending manager at KEMBA Financial Credit Union in Columbus, OH.
It's easy to tell if an application is going to lead to a credit inquiry of some kind: The bank, retailer, or insurer will ask you for your Social Security number.
"If it's just a discount club, and they don't want a social security number, then it's safe," she says.Step Three
Make all the applications for your car loan within a short span of time. You want to convey to the three main credit rating agencies (Experian, TransUnion and Equifax) that you are simply shopping for a car, not hunting for badly needed cash. It won't hurt your credit score if you do all your loan applications within a two-week period, experts say.
"You may go from car lot to car lot, and they all pull your credit report. So you end up with lots of inquiries," Cunningham says. "But if they occur within two weeks, they only count as one inquiry."
Do as much research online or in conversation with loan officers before you apply. That way, you can zero in on a few lenders and confine your applications to a short period.
If you decide to postpone your car purchase, it may be a good idea to wait four or five months before beginning another round of applications, Broseus says.
Don't max out your credit card balances before your purchase. In fact, if you can scale back your debt before you apply for a car loan, your credit score will likely improve. "In the creditor's eyes, if you have maxed out your credit, then you have no emergency backup and therefore you pose a little bit higher risk," Broseus says.
Another strategy is to apply for your car loan after you have made your credit card payments for the month, especially if you typically pay off entire balances. If you apply before you have made your payments, your debt load will appear higher. That, in turn could depress, your score. The ratings agencies are absolutely fixated on how much credit is available on credit cards. That's why it's important to keep cards active even as you reorganize your finances.
"This is where a lot of people get tripped up," Cunningham said. "They want to streamline their finances and they close their unused cards."
And if you have several cards, it may make sense to transfer balances in a way that each has a substantial unused balance on it. Ideally, none should be maxed out. Similarly, if you ever get a bill consolidation loan, you should put up a fight if your bank suggests that you close all your accounts.
"It's a good idea to hang onto at least one major credit card," Broseus said. "That credit line will tend to improve your FICO score because it indicates you have access to money in an emergency."Step Five
Avoid other purchases if they involve taking on new debt. A new refrigerator or patio might be tempting, but that's a new inquiry on your credit, and if you are approved it is going to be new debt. Normally, this would merely make a temporary dent in your credit score, she said. But it could make a difference if you have a marginal credit score in the first place.
It's not easy to keep track of the ratings agencies' arcane ways. But if you pay your bills on time, pay down debt and increase the amount of your untapped credit (without taking on new loans or credit cards), your credit score will improve.If your score is low, it won't reach stellar levels instantly. But even short-term measures could yield $1,000 or more in savings when you arrange financing for your car -- which could set you on the path to a much higher credit score and an even lower interest rate on your next car loan.