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Should I Pay Down My Debt Before Financing A Car?

Yes, you should pay down your debt before financing a car. On a basic level, the logic is simple:  you want to minimize your existing debt before taking on new debt. But, if you we look more deeply into the auto finance process, there are specific factors at work.

Credit Utilization and Vehicle Financing

Your credit score is a major determining factor when lenders consider your car loan application. It is also considered when the interest rate that you will be offered if the application is approved. The majority of lenders will look at your FICO auto-enhanced credit score. Thirty percent of that score is built based on the amounts you owe compared to the credit limits or beginning balances. This is known as your credit utilization ratio. If you have balances on your credit cards that are up to or in excess of 70% of your credit limit, then your FICO score could be negatively impacted. Ideally, you want to have a balance of no more than 30% of your credit limit on any revolving credit accounts like credit cards. Carrying a high balance not only costs you a lot in interest, it shows lenders that you are not good at paying down your debt on a monthly basis. This could translate into higher auto finance rates.

Debt-to-Income Ratio

Additionally, your total debt-to-income (DTI) ratio will be considered before your loan is approved. Most lenders want to see that you owe less than 40 percent of your before tax income for debt payments. That ratio will include the payment for the loan being considered. Lenders may require that you have a lower DTI if you have a lower credit score. Basically, lenders are looking to see whether you have sufficient monthly cashflow to handle not only your existing debts, but the new vehicle loan you are about to take on. If it is too much of a stretch, you will be at a higher risk of default. This translates into higher interest rates and more difficulty with credit approval.

Paying down your debt will not only help your loan be approved, but it will help you to be offered a lower interest rate.

About the Author

The author has many years of experience in automotive finance and insurance. However, each consumer's situation is unique. It is best to contact a finance specialist for further assistance.
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