Your credit is a crucial component of your financial health and plays a key role in your ability to secure a loan, buy a home, or get approved for a cell phone. Your history of financial decisions directly influences your credit, so if you’ve been haphazard with your spending and loan applications in the past, your credit will suffer. On the other hand, healthy spending habits will do wonders for your credit, which can give you more freedom and flexibility when it comes to loans and credit in the future.
There are specific and important factors that play a role in how healthy your credit will be. Specifically, there are five characteristics that lenders consider when someone asks them for money. You should be familiar with them as they make up your entire financial and credit profile or credit score. They are commonly called the “5 C’s of Credit”.
Your character is an important factor when it comes to a lender approving you for a loan. A lender defines character as how trustworthy, reliable, and responsible you are with your finances. Lenders use your history and reputation among previous lenders to assess your character, as they prefer to deal with borrowers who demonstrate they keep their credit commitments. In this world your character is measured by your credit. Your credit report contains important information for lenders to review when assessing you for a loan.
As you may have guessed, capacity refers to your ability to make your loan payments. A lender will not loan funds to someone they do not believe has the capacity to make the payments. When you take out a loan, you commit to repay it in full by a specific date.
Your income, net worth, and job stability are things lenders look at to determine capacity. Lenders want borrowers who have a steady, full-time job and make enough income to cover their loan payments after all other debt obligations and expenses have been satisfied. They will need to know what your existing total debt is to calculate your debt-to-income ratio (DTI). If your DTI is too high your income is not high enough to add an additional loan payment. Lenders may need proof of income and employment, tax returns, bank statements, and pay stubs to verify their income.
Capital is just another term for your net worth. This is calculated by taking the value of your assets (your house, your car, your investments, etc.) and subtracting your debts. It is what you own minus what you owe. The higher your net worth is the less risky you will be to a lender. Capital can also refer to a down payment you make on the loan. When applying for a car loan, any money you can pay for the vehicle upfront will increase your chance of securing the loan. Not only will it make the loan smaller, but it is also a positive sign to the lender that you’re serious about paying the money back. You have “skin in the game”.
Collateral refers to any asset that is used to back a loan. For instance, a car loan is collateralized by the car, and a mortgage is collateralized by the home. In both cases, the loans are considered “secured” because they both come with collateral that the lender can repossess if the borrower defaults on loan payments.
Secured loans give lenders security knowing that they have some way to recover their funds if the borrower does not keep up with loan payments. Collateral protects the lender during the loan term. Unsecured loans, on the other hand, do not come with any collateral, which puts the lender in a riskier position. Interest rates tend to be lower with loans that involve collateral.
The conditions of the loan refer to the interest rate, the amount you are borrowing, and how long the loan will be. Lenders will restrict what you can use the money for. In the case of a car loan, a condition of the loan is that the money must be used to purchase a vehicle. Other conditions, such as the current economic climate, may also be taken into consideration.
Credit Score (from Equifax Canada)
Credit scores are designed to predict the likelihood that individuals will pay their bills as agreed. Credit scores are only one of several pieces of information used to determine your creditworthiness. Payment history, the amount of credit you are using, and the length of your credit history are factors included in calculating your credit scores. Credit scores are intended to help financial risk managers and others make fair decisions about “taking a risk” on someone. The risk might involve giving that person a loan (will they repay it?), offering a credit card (will they make the payments?) or approving their apartment rental application (will they pay their rent?).
While your credit score is important, it is only one of several pieces of information an organization will use to determine your creditworthiness. For example, a mortgage lender would want to know your income as well as other information in addition to your credit score before it makes a decision.
How Are Credit Scores Calculated?
The main factors involved in calculating a credit score are:
- Your payment history
- Your used credit vs. your available credit
- The length of your credit history
- Public records
- Number of inquiries into your credit file
If you look at your credit scores based on data from both national credit reporting agencies – Equifax and TransUnion – you may see different scores. This is completely normal. Each credit bureau has multiple scoring algorithms and lenders typically request only one of them when making decisions. While all score versions have the same purpose (to predict the likelihood people will pay their bills), there are some differences in the calculations.
There are many different scoring models and here is a general breakdown of the factors the models consider:
- Payment history: ~35%
Your credit history includes information about how you have repaid the credit you have already been extended on credit accounts such as credit cards, lines of credit, retail department store accounts, installment loans, auto loans, student loans, finance company accounts, home equity loans and mortgage loans for primary, secondary, vacation and investment properties.
In addition to reporting the number and type of credit accounts that you have paid on time, this category includes details on late or missed payments, public record items and collection information. Credit scoring models look at how late your payments were, how much was owed, and how recently and how often you missed a payment. Your credit history will also detail how many of your credit accounts are delinquent in relation to all accounts on file. For example, if you have 10 credit accounts (known as “tradelines” in the credit industry), and you have had a late payment in 5 of those accounts, that ratio may impact your credit score.
- Used credit vs. available credit: ~30%
A key part of your credit score analyzes how much of the total available credit is being used. Also included in this factor is the total line of credit or credit limit. This is the maximum amount you could charge against a particular credit account, say $2,500 on a credit card.
- Credit history: ~15%
This section of your credit file details how long your credit accounts have been in existence. The credit score calculation typically includes both how long your oldest and most recent accounts have been open. In general, creditors need to see that you have properly handled credit accounts over time.
- Public Records: ~10%
Those who have a prior history of bankruptcy or have had collection issues or other derogatory public records may be considered risky. The presence of these events may have a significant negative impact on a credit score. Negative credit events typically drop off your public record in seven years.
- Inquiries: ~10%
Anytime an individual’s credit file is accessed for any reason, the request for information is logged on the file as an inquiry. Inquiries require the consent of the individual and some may affect the individual’s credit score calculation. The only inquiries which may impact a credit score are those related to active credit seeking (such as applying for a new loan or credit card). These inquiries are known in industry jargon as “hard pulls” or “hard hits” on your credit file. The hard inquiry may be the leading indicator, the first sign of financial distress that appears on the credit file. Not every inquiry is a sign of financial difficulty, and only a number of recent inquiries, in combination with other warning signals on the credit file should lead to a significant decline in a credit score.
Your credit score does not take into account requests a creditor has made for your credit file or credit score in order to make a pre-approved credit offer, or to review your account with them, nor does it take into account your own request for a copy of your credit history. These are some examples of “soft inquiries” or “soft pulls” of your credit.
We deal with all the major Canadian banks plus some specialty automotive lenders. Big banks have transferred the automotive financing segment of their portfolio to automotive dealers. Car dealers get better rates from the bank than most people do at their own bank on a personal loan. Vehicle buyers can access the best possible financing terms on new or used vehicles at their local dealer as they shop for their new ride.
Business Manager Role
The Finance & Insurance (F&I) Manager assists new and used vehicle buyers with financing and insurance. They offer products that protect the buyers, enhance the vehicle’s value and enjoyment, and protect your investment. F&I managers work with lenders to negotiate fair interest rates for buyers.
They represent the manufacturer to the buyer as they communicate the warranty options available. They represent the dealership to the buyer as they review the details of the agreement for sale and arrange for the transfer of ownership. F&I managers also may represent other companies to the buyer depending on the choices the buyer makes while buying their vehicle.
They are responsible for accurately completing all paperwork, registering warranties and other policies, and explaining all the products and services that may be available with the vehicle purchase. As with all positions within dealerships, F&I managers are expected to uphold the highest ethical standards.
Cash vs Credit
A true cash buyer has the funds on hand to purchase their vehicle. However, many cash buyers may actually be borrowing on a line of credit or taking funds from an investment account. Some people will use cash obtained by re-mortgaging their home to purchase a vehicle. It is cash to the dealership but there is a “loan” created by using a Line of Credit, or by taking money out of an investment account. That money must be paid back according to the terms of the instrument used.
We strive to save you money if you are using your line of credit, investment funds, or re-mortgaging your home and buying a vehicle with some of the funds. Please ask us for details.