Bad credit's double-whammy on car payments

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If you have bad credit, you probably know who you are. Now that car dealers are making subprime loans again, you're braced to pay more for a car loan.

A buyer with prime credit 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 $25,000 loan by $59 a month.

Ouch.

But what you may not be ready for is a bigger auto insurance bill. Even with a flawless driving record, a change in your credit from excellent to subprime easily could cost you an additional $30, $50 or $100 a month.

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

"People with bad credit can find life is expensive, even if they never plan to borrow another dime," says personal finance columnist Liz Pulliam Weston , who wrote "The 10 Commandments of Money: Survive and Thrive in the New Economy."

Bad credit makes life expensive

Americans' 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 poor credit grew by 13.8 percent last year, says Experian. Used-cars loans to the same group were up 8 percent.

Insurance companies use risk scores ( FICO is the largest provider) calculated from the same credit reports used for your other credit scores. The calculations are tweaked a bit but largely reflect your credit situation. Insurers pay attention to your credit 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.

California, Hawaii and Massachusetts don't allow insurers to use credit information to set rates. In states where use of risk scores is legal, 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 "full coverage" insurance -- not just state-mandated bodily injury and property damage liability coverage, but the comprehensive and collision coverage required by lenders to repair the car itself.

Gusner compared online car insurance quotes for both drivers on $50,000 liability per injured person, $100,000 per accident and $50,000 in property damage liability, plus collision and comprehensive coverage. Jenny and Nathan both chose a $500 deductible.

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

Credit makes a big difference for both our hypothetical buyers.

Buyer Credit score Risk score Car payment Insurance payment Total
Nathan 740 or above 700 or higher $350.15 $73.83 $423.98
680-739 600-700 $393.27 $93.33 $486.60
550-619 599 and below $439.10 $96.08 $535.18
Jenny 740 or above 700 or higher $515.79 $88.66 $604.45
680-739 600-700 $531.84 $131.16 $663.00
550-619 599 and below $599.25 $197.25 $796.75

Nathan insures his Nissan Frontier

Nathan is 24 and he lives in Washington state. He's buying 2010 Nissan Frontier truck for $23,800, the Kelley Blue Book private party value. With a trade-in credit of $5,000, he's financing $18,800 on a five-year used-car loan.

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 $74 a month for car insurance, Gusner found, or as much as $96 -- 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 $112 a month. Over time, a hit like that takes its toll. (See "Great credit saves you $22,815 on your car insurance premiums.")

Jenny, 41, lives in Albany, N.Y., and is the proud buyer of a new 2012 Toyota Prius with every option. Paying Kelley Blue Book Fair Purchase Price with $4,500 down, she's financing $28,500 over five years.

Buyers of new vehicles get slightly lower interest rates on 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 record would cost Jenny nearly $200 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. (See "Estimating car insurance rates: What you need to know.")

But where you live matters a lot, too, because there's no getting around the laws in your state that make car insurance cheap or expensive. Car insurance is much more expensive in New York than it is in Washington state. A poor credit record simply makes the pain worse.

You can fix it, though.

"Nothing is permanent in the world of credit," Weston 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."

Erasing a foreclosure or bankruptcy typically takes three to seven years, Weston says.

And, Gusner notes, unless you've put down 20 percent, you'd be wise to add a gap insurance policy to your coverage -- or risk deepening your credit troubles if you have a car accident.



The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of The NASDAQ OMX Group, Inc.



This article appears in: Personal Finance , Insurance

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