What Car Shoppers Need to Know About Credit Reports

Smart car shoppers do their homework before setting foot in a dealership. They research makes and models, read the expert reviews on Edmunds, and know what vehicle they want before talking to a salesperson.

And of course almost everyone realizes that a car dealer or lending institution will want to evaluate a potential buyer's credit report before agreeing to a loan or lease. But sometimes even the most savvy consumers don't really understand the specifics of what goes into that report, even though it may determine whether they drive away with the car of their dreams.

Credit Report vs. Credit Score

Since credit reports and credit scores are so closely intertwined, there's often confusion about what each is and how each is used.

A credit report is a record of your current and past interactions with lenders and others with whom you've had financial dealings. The parties can include banks, finance companies, mortgage holders, landlords, utility companies and wireless phone providers.

The report contains such details as dates when accounts were opened and closed, loan amounts, current balances and payment history, including late payments and defaults, as well as requests for the credit report from potential lenders. It also contains information from public records, such as debt collections, bankruptcies, court judgments and tax liens.

A credit score sums up a consumer's credit health at a glance.

This information is compiled by credit reporting agencies, the best known of which are Equifax, Experian and TransUnion. They maintain huge, complex databases of consumers' credit purchases and payment history gathered from lenders, retailers and others, such as auto dealers, who then use the agencies' services for future reports.

The credit agencies use their data to produce sophisticated models that can predict an individual's likelihood of making payments reliably. This data, in turn, is used to generate a number called a credit score, which sums up a consumer's credit health at a glance.

What Goes Into a Credit Score?

The most widely recognized credit score, the FICO score, is produced by the Fair Isaac Corp. There are other scores available, but FICO scores are used in 90 percent of the lending decisions in the U.S., so it's important to know how they're compiled.

Base FICO scores range from 300 to 850, with higher numbers indicating better creditworthiness. The exact components that make up the score are proprietary, with more than 30 factors taken into account, but these are generally grouped into five major categories:

• Credit history: This is a big one, accounting for 35 percent of the total score. When a consumer misses payments or is consistently late, it sends up a major red flag to lenders. They want to know you're going to pay them back for your car.

• Total amount owed: Another major component, this is responsible for 30 percent of the total. Lenders see a large backlog of debt as a poor indicator of the ability to repay new loans.

• Length of credit history: Making up 15 percent of the score, this shows how long you've had a credit history, as well as how long current accounts have been open. A longer history gives lenders more information on which to base decisions.

• Type of credit: This usually accounts for 10 percent of the total, but it can be more for borrowers with a short credit history. A good mix shows that a consumer can handle different types of credit, and of course a lender will pay special attention to loans similar to the one being considered.

• New credit: This includes both new accounts and recent "hard inquiries" and makes up about 10 percent of the score. Too much new credit can indicate cash-flow problems. Hard inquiries occur when you apply for credit, and too many of them can affect your score and whether you get the loan. "Soft inquiries," such as when you order a copy of your own score, don't affect the total.

You Have More Than One FICO Score

When you order a free copy of your FICO score online from one of the agencies or another source, you're getting the base score, which is a good general indicator of your credit health. But FICO develops separate scores for each of the major credit agencies based on the data they've each collected. Although those scores are generally fairly close, your Experian score can vary from your Equifax score. More importantly for car shoppers, there are industry-specific FICO scores for different types of businesses, such as automobile lending.

The FICO Auto Score, with a range of 250 to 900, starts with the base FICO score and then refines it to predict more accurately how likely you are to repay a car loan. Although the exact mechanics are proprietary, the FICO Auto Score differs from the base score by, for example, ignoring collection agency accounts that have been paid off, as well as unpaid medical accounts.

The latest version of the Auto Score adds a trends component that is pulled from TransUnion's data to provide a snapshot of a 30-month span of a consumer's credit behavior in more detail. Among other information, it shows lenders whether your credit card balances have been increasing or decreasing, whether your overall use of credit has been going up or down, and if you've been making more than the minimum payments on revolving accounts.

Is a Credit Report Necessary?

Obviously, a car dealership will need a copy of your credit report if you apply for a loan. But there are number of other reasons that a dealer might request a credit report at various times during the shopping process. A dealer might want to run a credit check for its own convenience, but sometimes the request comes from a misinterpretation of regulations. Occasionally, it's a tactic that's not in your best interest as a shopper. Here are some common situations:

• Often, dealerships will want to run a credit report for a cash buyer to ensure that if the customer's personal or cashier's check fails to clear, the dealership can still send the shopper to a bank to get funding for the vehicle being sold.

• Some dealers may tell cash buyers that they need to run a report due to regulations in the Patriot Act. In fact, that anti-terrorism legislation only requires that dealers check the names of certain cash buyers against the Office of Foreign Assets Control's list of specially designated nationals and blocked persons. This situation does not require a credit report.

• Regulations also require dealers to inform the federal government of instances of cars purchased in cash for more than $10,000. This rule is intended to help prevent money laundering. Paying cash does not require a credit report, although you may need to give the dealership your Social Security number for reporting purposes.

• A dealership might try to get potential buyers to fill out a credit application or provide enough personal information for a credit report before a test drive. This may be especially true if you're there to road test a high-dollar exotic sports car. Assuming you are a qualified shopper, you don't have to give your permission for a credit check and can test-drive elsewhere if you're asked to fill out an application before you're ready.

• It's rare, but some dealers want to know how much you can afford to spend before quoting a price on a car. A healthy credit report is a good indication of someone who can afford to pay more. Your research on what a car should cost and your negotiation plan are a hedge against such a tactic.

How to Head Off Credit Trouble

Consumer advocates are quick to point out that no one can get a copy of your credit report without your permission, but keep in mind that permission can be given verbally. So if you're not ready to apply for a car loan, don't provide your Social Security number or other detailed personal or financial information, even in conversation. And definitely don't sign a loan application until you're really ready to buy.

Perhaps most importantly, get copies of your credit reports from all three major credit reporting agencies and check your credit score yourself before going to a dealership. Having that information will let the dealer know that you're a knowledgeable shopper and will help you avoid making a potentially costly mistake.