I received a reader question last week about how credit cards and available credit will affect her ability to get a favorable rate on a car loan.
Now let’s look at her question:
I am writing because I was curious what effect my credit cards will have on getting a car loan with a good interest rate. I have 6 credit cards that total an available balance of $14,500. When I say available I mean just that, the balance on all the cards is zero and has been for about 6 months.
I was deployed to Iraq and decided to get out of debt first thing. Paid them all off in a matter of 5 months.
One of the cards is almost 7 years old, 3 of them are 5 years old and the other 2 are about 2 years old.
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I was discussing this with someone and they mentioned that lenders may frown on me having that much available credit.
My income is quite low while I am home because I am also a college student therefore I can’t claim my GI Bill as income because it’s contingent on me attending school.
So I would say I gross about $16,000 a year while at home as far as what can be considered toward my income to debt ratio.
Will these cards hurt or help me and what is the best scenario if it is more beneficial to close the accounts, considering I want to buy a car within the next 6 months.
Thank you for contacting me, and thank you for your service to our country. And congrats on eliminating your debt, that puts you in a much better financial position to obtain favorable loan conditions!
To answer your questions I will also reference some articles I have previously written. The links are below so you can find more details.
- Understanding Your Credit Score
- How to Improve Your Credit Score
- Think Twice Before Canceling Credit Cards
With the information in the above articles, you should understand how your credit score is determined, how to improve it, and why canceling your cards may not be a good idea – particularly your older credit cards.
You should already have a high credit score. Your credit score is determined by your payment history (35%), amounts owed (30%), length of history (15%), new credit (10%), and type of credit (10%). You can reference the above articles for more information. Based on this formula, you should have a good score, so long as your payment history is good (ie you haven’t missed (m)any payments). Everything else is in your favor – you don’t owe any money, the length of your credit history is good, and you don’t have any new credit. I don’t know the type of credit you have, and some types are less favorable than others – for instance a payday loan is less favorable than a major credit card.
Don’t cancel your credit cards. Canceling your credit cards reduces the average age of credit, which can lower your score. A better alternative is to request that the credit card companies reduce your available credit on the cards you don’t use. If you feel like you don’t need a lot of available credit, reducing all but one card to a minimum level (probably $1,000) will reduce your amount of available credit and may make it easier for you to get a favorable loan rate.
Debt to income ratio. Your ability to borrow money is based on more than just your credit score. Lenders also consider your income, debt to income ratio, and other factors. Your credit limits don’t actually count toward your debt to income ratio because it is only available credit, not credit you are using. Your debt to income ratio is currently 0 because you have no debt. When you take on a loan, your debt to income ratio will change, but unless you get an expensive car, your debt to income ratio should be relatively low.
Loan rates vary. There are many factors that lenders use to determine the rates they will offer. Your credit score should be high, which is in your favor, and you can lower your available credit by reducing the limits on your credit cards. The biggest factor you have going against you is your low income. If you can demonstrate to your lender that you are living at home, have few expenses, and have sufficient income, you may be able to receive a good loan rate.
My advice: You have 6 months before you plan on buying a new car, so save up as much as you can right now, and put the money in a high yield savings account, where you can earn interest on your money while you wait.
I recommend doing your homework before buying a new car and before taking on a loan. Examine you needs now, and look ahead a few years – if you plan on getting married or starting a family in the near future you don’t want to buy an economy car now and need to trade it in in a few years if your needs change. Since your income is low, try finding a quality used vehicle that meets your needs, and consider buying a car that is closer to the entry level line than the luxury level line.
Then shop around for interest rates. Try your bank first (I currently use and recommend USAA, but go with whichever bank you are comfortable with). And don’t be afraid to check out dealer financing options. Many dealers are hurting in the current economy and may be able to give you a good deal.
I hope this information helps, K. Good luck in finding a good car at a good rate!