More than 90% of cars sold on the market are financed, and as a matter of fact, even those with the means to purchase a car in cash prefer to finance their cars due to the low interest rates and incredible leverage currently available in the auto market around the United States. While financing a car may seem attractive, it is an important financial decision that, if not made properly, can hurt your financial situation much more than help it. This is why we decided to put together a basic guide to understanding what credit scores and factors are needed for you to buy your next luxury or exotic car.
In the dealer world, credit is very different than in the world of banking. It is important to understand that dealers deal with automated guidelines and wholesalers rather than bankers, allowing them much more flexibility based on their relationships with certain wholesalers at certain banks. In other words, just because one dealer can’t approve you that doesn’t mean another cannot do so with the exact same bank.
So what do dealers and wholesalers look for and how does this process work?
Most dealers have their own financial applications on their websites or on paper that helps them evaluate your credit before submitting it to banks (using a tool called Dealertrack) which allows them to submit to multiple banks at the same time once they know your financial situation. Good dealers are strategic in their approach and only submit you to one or two banks versus inexperienced dealers that send you to all banks. A good dealer will know the guidelines of the banks they submit to, making it easy to know ahead of time what you will qualify for.
So what do banks look for?
Obviously your credit score matters, and it holds a lot of weight, but there is also the LTV on the car known as the Loan to Value and your credit history (previously financed cars and your behavior).
The breakdown of your score is as follow:
720+ Tier 1: You have leverage and qualify for the best rate. It is likely that you will receive the best rate and term on your car loan.
650 – 720 Tier 2: You can still qualify for a loan, but the dealer may play hardball to sell you a higher rate so they can make more money.
600 – 650 Tier 3: While you won’t get a car based on your score alone, there is still hope; but expect to pay a premium in the rate you are given, and perhaps restrictions on the terms as well.
The second piece to the equation is your LTV (Loan to Value). When you buy a car, banks will use Black Book Value, usually aligned to NADA clean retail, to determine their liability and what your down payment should be. Banks are aware that dealers need to make money on their sale; and therefore, will allow LTV to go up to 120% of the clean retail meaning if a car’s value is $100,000, most banks will allow the dealer to finance up to 120% of that number which is $120,000.
However, the closer the value of the loan (total financed) approaches the 120% mark, the higher the bank risk; therefore, a higher down payment will be needed if your credit score isn’t above 720. The higher your score, the more lenient the bank is with letting you get away with less money down and a higher LTV.
Those with poor credit will need to stay under 80% in LTV because banks want to limit risks, and since dealers will typically not cut prices low enough, then you are required to compensate the difference in cash.
The third and final piece a bank looks for is your past history of cars financed and the total loan value of your previous cars. Banks don’t like people with no history and certainly don’t like people who go from $200 car payments to $1500 car payments. They often favor those who systematically go up in amounts rather than make large jumps.
While the amount you are approved for is typically based on your income, the bank also understands that when you go past $70K loans, it is not a question of necessity, but rather preference and therefore will limit such preference by allowing reasonable jumps unless compensated by a bigger down payment.
Here are two scenarios for you to understand how this equation works from beginning to end:
a) Perfect candidate would be someone with 720+ credit score buying a car valued at under 100% of NADA clean retail value and with a history of past cars within 40% margin of past cars financed. This candidate qualifies for the best rate.
b) Bad candidate would be someone with an average or below average credit score trying to buy a car over valued by a greedy dealer and whose past history only shows cars around $15K but now wants to buy a $80K car. This guy will need a very large down payment and will most likely pay a high rate.