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How Does My Credit Score Affect My Interest Rate?

02/12/2019 @ 5:51 am

When you take out any kind of loan, from a credit card to a car loan in Oakville, one of the most important numbers to you will be the interest rate you will be charged.

This number has the potential to turn affordable repayments into bank breaking financial burdens, which can lead to missed payments and a ruined credit score if care isn’t taken.

One of the main things that influences the interest rate that will be offered to you will be your credit score. This all important number has the potential to completely change the kinds of loans you will be eligible for and how much you’ll need to fork out each month.

So how exactly does your credit score affect your interest rate?

There are several ways your credit score will alter the rates you’re offered. We’ve put together a guide to answer many of the most common questions surrounding this topic. Read on to find out more!

Visual representation of interest rates on bad credit car loans in Oakville

What is an interest rate?

First of all, let’s begin by defining what an interest rate actually is when it comes to your new loan.

An interest rate is an agreed upon percentage of the remaining principal amount of a loan that will be paid in addition to the repayments to cover the borrowed amount. The interest is usually calculated every month on whatever is remaining on the borrowed amount. This means that as you get towards the end of your loan, while your monthly repayments will remain the same amount, the percentage of the payment that is made up of interest will decrease. This means by the end of your loan, each of your repayments will be mostly equity you are buying directly into your car, as opposed to giving the lender money for the service.

How is my interest rate calculated?

Now that we know what an interest loan is, we have to understand how it is calculated.

When you apply for a car loan in Oakville, you will need to take a close look at how much interest will be charged n your car loan. The numbers you will see will likely vary considerably, from 2% through to 20%. Which number you get exactly will depend on a few things:

The prime interest rate

The prime interest rate is a rate decided upon by the Bank of Canada which dictates which rates banks and financial institutions will typically offer to their most creditworthy customers. As of February 2019, the prime interest rate in Canada is 3.95%. This means that someone with an extremely good credit score (likely 850 or higher) might be offered this rate. Generally, banks will add a little bit more on top of this rate to bolster their profits, and if the applicant has average or poor credit, they can add over 15% more to this rate. The prime rate is also used to determine the interest rate applied to variable loans like mortgages. If the prime rate were to go up, your monthly payments would go up too. However, should it go down, your payments would also go down.

Your credit provider

The specific lender you go with will also have some impact on the interest rate you are offered. Generally speaking, banks have a lower appetite for risk when it comes to lending, and so will be more likely to offer higher interest rates to people with average or below credit. Conversely, there are lenders that cater specifically to people with subprime credit, such as Oakville Bad Credit Car Loans, that can leverage their extensive lender networks to get better interest rates for their clients. It definitely pays to shop around on your car loan provider to ensure you are getting the lowest rate possible for your situation.

Your credit score

Another element of your application that will dramatically affect your interest rate is, obviously, your credit score. Your score is a numerical representation of your credit history and how you have dealt with credit in the past. This will include any missed payments, defaulted loans, or declarations of bankruptcy. Every lender will use your credit score to some degree to determine the interest rate they offer to you, as it is a way to protect themselves from potential lost profit. Interest rates are also one of the key driving forces behind the entire credit score system, as without the incentive of being offered low interest rates, there would be little reason for consumers to strive to improve their credit scores.

How much of a difference does my credit score make?

So now we know what an interest rate is and how it is calculated, but how much of a difference does your credit score actually make? The short answer is – a lot.

The longer answer is that your credit score plays the most significant role in determining what interest rate you will be eligible for based on your lender’s appetite for risk. If you apply for a car loan in Oakville with a credit score of 750 or over, you will likely be offered a very good interest rate. This is because you are seen as a low risk investment for most credit providers, and they know they will need to be competitive to win your business against other lenders. This encourages them to offer good rates, and encourages consumers to maintain good credit scores to save themselves money in the long run.

On the other hand, should you apply for a bad credit car loan in Oakville, you might find that your interest rate is considerably higher than the prime interest rate. As mentioned above, this is used as an insurance of sorts for your credit provider, to help protect their investment against a defaulted loan as you are seen as a risker applicant than someone with good credit. This is the unfortunate reality of the credit score system, but it is a necessary evil in having a sustainable credit framework that incentives investment and responsible credit use.

Can I renegotiate my interest rate?

If you have been given a high interest rate due to your below average credit score, never fear. Once your credit score has improved, you are more than welcome to renegotiate your interest rate to secure a better deal.

One of the best aspects of taking out a bad credit car loan in Oakville is the opportunity to rebuild your credit score naturally. By making regular, on time repayments on your loan, you will steadily improve your credit history and your credit score. After just one year of these payments, your score is likely to have improved significantly enough that you will be eligible to leverage this in the form of a better interest rate. At Oakville Bad Credit Car Loans, we always offer to renegotiate your car loan after one year to ensure you are always paying the lowest amount possible. Our dedicated team of car loan experts will shop your loan around to our network of lenders to secure the lowest rate possible based on your improved score, which could end up saving you thousands over the life of your loan.

Never be afraid to ask for a better interest rate on your car loan. If your score has improved even a little bit since you first took our your loan, you are almost guaranteed to be able to secure a better interest rate from a lender, even if it’s with a different one than you’re currently with.

Man checking credit score for bad credit car loan in Oakville

How do I improve my credit score?

This brings us to the crux of the issue when it comes to credit scores and interest rates – how do you improve your score to access better interest rates?

Contrary to what many people believe, your credit score isn’t an immovable number that is stuck with you forever. It changes every month, and can be readily influenced by a number of relatively straightforward tactics. By focusing on boosting your score before you apply for a car loan in Oakville, you can ensure you are offered the lowest interest rate possible.

Maintain your credit utilization ratio below 30%

Your credit utilization ratio is calculated by dividing the amount of credit you have actually spent by the amount of credit you have been approved for. For example, if you have spent $500 on a credit card with a $1,000 limit, your credit utilization ratio would be 50%. Credit bureaus have revealed that up to 30% of your credit score is based off your monthly credit utilization ratio, and they have recommended that consumers try to keep their total ratio to below 30% across all their revolving credit accounts. It is wise to also try to keep each individual credit card to a ratio of 30% or less to minimise the negative impact your spending might have on your score.

Don’t close cleared credit accounts immediately

Perhaps counterintuitively, closing a credit card with a zero balance can actually hurt your credit score based on the above ratio. If you have a credit card with a $2,000 limit with zero owing, that’s an additional $2,000 of total approved credit in your pool that can help lower your credit utilization ratio across your other revolving credit accounts. If you have your heart set on closing a credit card, you should first try to get all of your revolving accounts to 30% or less, and then consider opening another line of credit to boost your credit pool again.

Make regular, on time repayments

Other than your credit utilization ratio, your payment history is the other major contributor to your credit score. Seeing if you have had any late or missed payments in the past will be one of the first things a lender will look for when reviewing your application, and these events can dramatically impact your credit score. By ensuring you make consistent payments on your credit accounts, you can build up an impressive credit history that shows potential lenders that you can be trusted with credit. These repayments will contribute to a significant boost in your credit score over time, allowing you to renegotiate a better interest rate.