When shopping for a new car, you will likely be financing part of the vehicle's overall price in order to buy it. That means you'll have to go through a lender, whether it is a bank, dealership, or credit union. Understanding your credit score can not only give you an advantage when you go to finance your car at these institutions, but it can also help you budget properly.

What is a Credit Score?

Your credit score is a numeric rating ranging from 300 to 850, and it is generally determined by a system devised by the Fair Isaacs Corporation (FICO). Three major bureaus - namely, Equifax, Experian, and TransUnion - will usually supply scores to creditors. Basically, this rating represents your creditworthiness, or the risk involved in lending you money. The higher your score, the more likely a company will be to lend to you, and the lower your interest rates will be.

How is my Credit Score Calculated?

Your credit score is based on your financial past, which means it is comprised of your payment history among other things. Below is a complete breakdown of your score:

  • Payment History (35%)
  • Total Debt (30%)
  • Length of Credit History (15%)
  • New Credit (10%)
  • Types of Credit (10%)

Basically, if you pay your bills on time, it will give you a good payment history. However, as evidenced by the list above, you also need to consider other components. Try to make sure your total debt is only about 20% of your total income as well. The duration, or age of credit, simply makes your score more accurate, while new credit reflects the number of "hard inquiries" made recently. Finally, types of credit determine the quality of debt (credit card debt is usually worse than student loans, for example).

Increase Your Credit

The best way to increase your credit rating is to pay bills on time. You also need to regularly check your score, which can be done for free once a year at annualcreditreport.com (or call 1-877-322-8228), in order to look for mistakes and to understand your financial situation.

You should also carefully time "hard inquiries" by limiting the number of applications for credit (don't get a mortgage, credit card, and car at the same time). You can also save up for larger down payments to increase the likelihood that you will get a loan, or you can simply pay down debt from credit cards or other revolving-credit sources. Generally, paying off small debt is more helpful than paying off old loans.