Basically, most financial facilities affect your ability to get credit, but do car rentals feature among such transactions?
Creditworthiness is an issue of concern for most individuals that are edged on credit for growth. Generally, though, renting a vehicle won’t help you improve or build credit, but the process can affect your credit rating.
Car rentals affect several factors that are crucial to eyes of a lender:
- Hard checks
- Credit utilization ratio
- Your DTI ratio (if you rent the car on credit)
What is Good Credit?
Lending, just like other investments, requires due diligence to ensure profits. As such, a prospective lender would first want to go through your credit history to determine how much of a risk you are before committing to lending you.
Creditworthiness is normally summarized by a three-digit number known as a credit score. FICO, the oldest and the most common credit score, sums up your credit score in a range between 350 and 850 points.
The higher your score, the less the financial risk you pose to the lenders and hence the easier it is for you to get a loan. The bottom ceiling for good credit is roughly 680 points.
With this in mind, car rentals harm your credit score through the following ways.
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Making a Hard Check on Your Credit
Once you use your debit card to pay off car rental fees, the car rental agency may decide to check your credit. Though only by 5 points, or less, a hard check lessens your credit score.
However small or short-lived the effect is, it could contribute to credit denial by the prospective lender.
Furthermore, credit repayment history is the most crucial factor of your credit score. It takes 35% as much as your total score, followed closely by total amounts owed at 30%.
In the possibility that you fail to meet repayment deadlines for the car rental charges, the rental agency will turn to collection agencies. This will feature negatively in your credit report.
Unlike a hard check, a collection account adversely affects your credit score.
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Increasing Your Credit Utilization Ratio
Responsible credit card usage is an act that is widely advocated for. This entails prompt monthly settlement of bills and maintaining your credit utilization ratio at the least it can be.
Credit utilization ratio is how much you owe when compared to your credit limits. A favorable credit utilization ratio (CUR) is capped at 30%.
If your credit limit stands at $8,000 and you are currently utilizing up to $2,400 on credit, your credit utilization ratio is at 30%.
($2,400/$8,000×100)= 30%
So, if you make a $1,200 move for rental cars on credit, your credit utilization ratio shoots to 45%.
($2,400+$1,200)/$8,000×100= 45%
This is unfavorable to your credit. The reason being, lending to you would be addition of burden to an already burdened individual.
How Car Rentals Increase Your DTI Ratio
Debt to Income ratio (DTI) is the fraction of your income that is specifically dedicated to debt repayment. Prospective lenders don’t find it okay to extend funds to someone who is already burdened with loans.
As such, they highly consider your DTI ratio before making their decision.
The ratio is arrived at by dividing the total amount that is scheduled for loan repayment by the total amount earned by an individual.
A favorable DTI ratio is by norm described as any value that is below 43%. A lower DTI ratio implies increased credit worthiness.
To illustrate: If your monthly income is $4,000 and you spend $1,600 monthly to service existing debts, your DTI ratio will be at 40%.
Now, if you rent a car using your credit card at a monthly rental cost of $400, your DTI will rise to 50%. The extra 7 percentage points basically make you a credit risk to the next lender you approach.
The Takeaway
Car rental agencies don’t advertise minimum requirements when it comes to the credit scores of new renters. That said, however easy the process is, the facility can easily lower your scores, especially when you pay using a credit card and default on payments.
Using a debit card or cash can help you maintain your score. But since you may not always have cash when you need it, keep your DTI and CRU low to enable you rent a car on credit and not dent your scores.
