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11 May 2012

Bad Credit’s Double-Whammy On Car Payments

Vehicle Finance No Comments

Tristan Powys (Credit Counsellor) @ Lucid Living

If you have bad credit, you probably know who you are. Now that car dealers are making sub-prime (high credit risk) loans again, you’re braced to pay more for car finance.

A buyer with prime credit (low credit risk) paid an average rate of 4.54 percent for a five-year new-car loan in April, according to Experian. The typical subprime buyer paid 9.55 percent — increasing the payments on a R175,000 loan by R413 a month.

Ouch!

But what you may not be ready for is a bigger car insurance bill. Even with a flawless driving record, a change in your credit report from excellent to subprime easily could cost you an additional R210, R350 or R700 a month.

Below we offer some detailed examples on how a poor credit report hits car buyers twice.

“People with a bad credit report can find life is expensive, even if they never plan to borrow another dime,” says personal finance columnist Liz Pulliam Weston.

Bad credit makes life expensive!

South Africa’s credit scores have dropped during the recession. The average score for someone buying a new car or truck fell six points, to 761, by late 2011, says Experian, the credit-reporting agency. The average score of used-vehicle borrowers fell nine points, to 670.

As the economy recovers, though, lenders are more willing to offer loans to those who wouldn’t have qualified a year or two ago. New-car loans to customers with bad credit grew by 13.8 percent last year, says Experian. Used-cars loans to the same group were up 8 percent.

Insurance companies use credit scores calculated from the same credit reports. The calculations are tweaked a bit but largely reflect your credit situation. Insurers pay attention to your credit report because it’s seen as a predictor of claims — and car insurance companies hate claims.

How much more does bad credit add to your insurance cost? There’s no easy answer.

8/10 car insurers use credit scores to calculate your car insurance premiums. Each insurer decides for itself what level of credit is acceptable and when to begin penalizing drivers below that mark.

Meet Nathan and Jenny

Penny Gusner, CarInsurance.com’s consumer analyst, assessed the damage a poor credit score might wreak on two hypothetical drivers: Nathan, who is buying a used truck, and Jenny, who is buying a new car.

Both have unblemished driving records and are looking for “comprehensive” insurance — including fire, theft and all risk.

We assumed that these drivers arranged 60-month car loans at prevailing average interest rates and purchased the cheapest insurance policies Gusner could find.

Buyer Credit score Car payment Insurance payment Total
Nathan >740 R2,451.05 R516.81 R2,967.86
550-619 R3,073.70 R 672.56 R3,746.26
Jenny >740 R3,610.53 R620.62 R4,231.15
550-619 R4,194.75 R1,380.75 R5,577.25

Credit makes a big difference for both our hypothetical buyers.

Depending on his credit, the car loan could cost him as little as 4.46 percent interest or as much 14.17 percent. At the latter rate, his monthly payment would increase 25 percent compared to the rate associated with top-notch credit.

He could pay as little as R518 a month for car insurance, Gusner found, or as much as R672 — an increase of 31 percent.

After combining the costs of both his car loan and car insurance, bad credit would put Nathan on the hook for an extra R784 a month. Over time, a hit like that takes its toll.

Buyers of new vehicles get slightly lower interest rates on car loans than buyers of used cars do, so that’s one thing in Jenny’s favor. With outstanding credit, she would pay as little as 3.29 percent for her new-car loan. With subprime credit, though, her interest rate would triple and increase her monthly payment by 18 percent.

Her insurance bill could take an even bigger hit: A subprime credit rating more than doubles her monthly insurance cost.

All told, a poor credit report would cost Jenny nearly R1,400 a month.

What can you do?

You might wonder why Jenny pays so much more for car insurance than Nathan does.

Nathan, after all, is a young male. In general, your age and sex matter even more than credit does when determining your car insurance rates.

But where you live matters a lot. Car insurance is much more expensive in Johannesburg than it is in Northern Cape.

A poor credit report simply makes the pain worse.

You can fix it, though.

“Nothing is permanent in the world of credit,” Kate Thambiran, MD of Lucid Living says, “so it’s always possible to rehabilitate your credit even after the most serious setbacks, and it’s worth the effort to do so.”

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