BY NATHAN SPIECKER for WEEKLY VOLCANO
The first time we apply for credit, whether it’s an auto loan, a credit card, or even a mortgage, it can feel like there is a lot at stake.
Imagine shopping for a first car and finding two lenders offering competitive rates. We might want to apply to both but hesitate. Won’t each application create a hard inquiry? Could comparing lenders hurt the credit score we worked to build?
It’s a reasonable concern. But avoiding comparison shopping can have a cost, too.
One of the reasons we work to build good credit is that it can give us access to better borrowing terms. A lower interest rate means paying less to borrow the same amount of money. If our credit helps us qualify for a better rate, it is worth finding out what different lenders are willing to offer.
So, what happens when we apply? A lender may review our credit report and score, income, existing debts, the amount we want to borrow, and other information before deciding whether to approve the application and what terms to offer. One measure a lender may consider is our debt-to-income ratio, or DTI, which compares monthly debt payments with gross monthly income. Generally, the less debt we carry and the more income we have, the more attractive we are as potential borrowers.
The lender may also make a hard inquiry when checking our credit. A hard inquiry can affect our score, but that doesn’t mean we should avoid applying to more than one lender. Credit scoring models generally recognize that people need to shop for certain types of loans. The Consumer Financial Protection Bureau points out that multiple inquiries for an auto loan made within a relatively short period are generally treated as a single inquiry for scoring.
The CFPB recommends keeping auto-loan shopping within a 14- to 45-day window.
That makes the first part of shopping fairly simple. Before filling out applications, look around. Banks, credit unions, and other lenders may advertise different rates and terms. Those advertised rates aren’t guarantees, since the rate we actually receive can depend on our credit and financial circumstances. But they can help us figure out which lenders are worth a closer look.
Then we can seek actual offers. Prequalification or preapproval, when available, can give us a better idea of what a particular lender may offer. This is where the numbers start to matter. A loan with a lower monthly payment isn’t necessarily the cheaper option. We should look at the APR interest rate, loan term, and total cost. A longer loan can lower the monthly payment while increasing the amount of interest paid.
Consider a $20,000 loan at the same interest rate. Stretching repayment from three years to six years can make the monthly payment substantially smaller, but the total we end up paying in interest can more than double. The payment may be easier to fit into a monthly budget, while the loan costs more in the long run.
The interest rate matters, too. On a $20,000 loan paid over the same period, a rate of 7% instead of 9% can mean hundreds of dollars less in interest. The exact difference will depend on the loan amount and term, but the principle is simple: a lower rate can leave more money in our pockets.
This is one reason the credit score we have spent this season learning about matters in the first place. A good score isn’t valuable simply because the number looks good. It can help us qualify for better terms when we apply for credit. But having access to better terms doesn’t guarantee that we’ll receive the best offer available.
That is where comparison shopping comes in. We don’t need to apply everywhere we can find a loan. We can first narrow our choices by looking at advertised rates and terms, then seek actual offers from lenders that appear competitive. A little time spent comparing can make a meaningful difference in what we pay.
And there is another number to keep in mind: the payment we can actually afford. A lender may approve a loan that fits its requirements, but that doesn’t mean the payment is comfortable for our household. Existing debts, income, and other monthly expenses all matter. We know more about our own budget than a lender does.
That brings us back to the first-time car shopper. Applying to one lender simply to avoid another inquiry might mean accepting the first offer without knowing what else is available. A better approach is to know where our credit stands, understand what we can afford, research several lenders, and then compare the offers.
The point isn’t to keep our credit score untouched at all costs. A good credit history and score can give us options. When we need to borrow, we can use those options to look for a loan that makes sense for our circumstances.
Before applying for a major loan, it is important to check our credit report and score, as we’ve been discussing throughout this series. Research several lenders and compare their advertised rates and terms. When we are ready to apply, we can seek offers from a small number of lenders and keep the applications for the same type of loan within a focused shopping period.
This is where a good credit score changes from just being a three-digit number into one of the tools that can help us get better terms when we need to borrow. Next week, we’ll take a step back from the application itself and ask a bigger question: When does using credit actually make sense?
This column is produced by the Washington State Department of Financial Institutions, Washington’s financial services regulator, to provide consumer education and protection. Learn more or file a complaint at www.dfi.wa.gov.
