Why Weak Credit Won't Kill a Car Loan
By: Jeff Brown

NEW YORK (sbup) – Most borrowers know that imperfect credit can kill one’s chances of getting an affordable mortgage, but a good car loan may still be within reach.

That’s worth remembering as more drivers head to the showroom. Kelley Blue Book expects that when the final numbers are in, January’s sales will beat sales the same time last year by 10%. KBB credits slight improvements in the economy, a dip in unemployment, and Americans’ growing need to replace vehicles after postponing purchases when the economy was weak.

Happily, car-loan rates are pretty attractive, with four-year new-car loans averaging just 4%, according to the manybanking.com survey.

Of course, mortgage rates are enticing, too, but many borrowers can’t get the advertised deals because of credit flaws, and can’t afford the bigger payments from the higher rates charged less-than-perfect applicants. But higher car loan rates aren’t as harmful for three key reasons.

First of all, auto loans are for smaller sums than mortgages – $20,000 instead of $200,000, for example – so interest charges are easier to bear, even at higher rates.

Second, auto loans typically run from three to five years, while most mortgages last for 30. Put simply, a higher rate won’t hurt you as much if you won’t be stuck with it for very long.

Third, because the vehicle loan will be paid off in just a few years, a big chunk of every payment goes to the principal balance, leaving a smaller portion of the payment to be subject to the interest rate.

On a four-year $20,000 car loan at 4%, payments would be $452 a month. In the first month, only $67 of that payment would be interest, or 15%.

Compare that to a 30-year, $200,000 mortgage at 4%. The payment would be $955 a month, with $667 going to interest in the first month, 70% of the total.

Now let’s look at what would happen to a borrower who had to pay 6% on each loan because of weak credit.

The mortgage payment would jump to $1,200 a month, with $1,000 going to interest. That jump could push the loan out of reach. Even if it didn’t, the borrower might not want to bear the long-term cost. At 6%, interest would come to $232,000 throughout 30 years, compared to $144,000 with the 4% loan.

But all of those numbers are more manageable on the car loan. Raising the rate to 6% from 4% would boost the payment a mere $18, to $470 from $452. Total interest over the loan’s four-year life would be $2,546, compared to $1,676 at 4%.

So how much does your credit rating affect the car loan rates you can expect? A recent survey by Edmunds.com, the car-data firm, found that a borrower with a credit rating of 720 or higher could get a four-year loan at 3.65%, while an applicant with a 630 to 669 rating would pay about 8%.

Clearly, it’s better to have a flawless credit history. But if you don’t, a new car may be within reach anyway.

Looking to buy a new set of wheels? Here’s what you need to know before making a purchase!

—For more ways to save, spend, invest and borrow, visit MainStreet.com.

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