It might seem downright impossible to get a car loan with bad credit, but it doesn't have to be. Auto loans are approved every day for people with low credit scores and little money to put down.
Different lenders consider a range of factors when deciding to offer an auto loan and your credit score is one of them. One of the top credit score models is FICO, and it counts scores between 300 and 850.
On that scale, anything below 670 is considered poor credit or fair credit. If your score falls below 670, then you may have difficulty qualifying for certain car financing terms. However, that doesn't mean that you absolutely can't get a new car.
Before you apply for a bad credit auto loan, it's important to take the following steps:
Step One: Check Your Credit Report
One of the first things you should do is take a look at your credit report so that there are no surprises. This way you can see exactly where your credit scores fall and if there are any items in your credit history that you should deal with. If your scores are low and you don't need a new car right away, then you should consider trying to improve your scores before applying for an auto loan.
Step Two: Can You Improve Your Credit Score?
There are a few different ways you can work to improve your credit scores. One of the top ways is to improve your payment history. If you have items in collections, try to pay them off. If you have any late payments, it's crucial to pay those immediately. Another way is to reduce your overall debt. One factor that lenders use is your credit utilization ratio. This calculates your total credit limit and the amount that you've used. For example, if you have a total credit limit of $10,000 and you've used almost all of it, this will present a very negative factor on your credit report. A good rule of thumb is to keep your utilization below at least 30 percent and preferably under 10 percent. Next, look at your credit report to see if there are any errors. Mistakes do happen, and they can affect your credit score.
Step Three: Research Auto Financing
With poor credit, you may find it difficult to get an auto loan from a conventional lender such as a credit union or personal bank. Instead, you may want to focus on lenders that make auto loans specifically for people with low credit scores. To serve people with low credit scores, these lenders typically offer loans with higher interest rates. Another option is to look for car dealerships that claim to work with buyers who have poor credit or no credit. Some of these dealerships have agreements with lenders that work with low credit car buyers, and some of them also have programs in place to finance loans themselves. Even though it's ideal for improving your credit before getting an auto loan, there are still programs out there to get you a car when you need one.
Step Four: Have a Down Payment
Having a down payment is always a good idea, but it can be an especially good idea for those with bad credit. A down payment, and a substantial one at that, can lower your monthly payments, and it may also show the lender that you do have resources to pay off your loan.
Step Five: Make Sure You Know How Much You Can Afford
You don't want to get in over your head with a subprime auto loan. Start by figuring out the monthly payment that you can afford. Using an online auto loan calculator, put in the total price of the car and an interest rate to see what you might be looking at. The Experian auto loan marketplace is one place to find out loan terms and current interest rates.
Step Six: Avoid Bad Credit Items
In the period leading up to your auto loan application, be on your best credit behavior. Don't add any credit obligations, especially new credit cards. Don't miss any payments and don't let anything go to collection. Other problems include filing for bankruptcy, tax liens and judgments from lawsuits.
Bad Credit Auto Loan Options
As previously mentioned, if you can raise your score before applying for a car loan, you're likely to save money with a lower interest rate and better loan terms. However, if you don't have the time or means to improve your credit score, then there are some alternative options. Consider the following possibilities:
Get a Cosigner
If you can get a cosigner with good credit and reliable income, then you can increase your chances of auto financing with better loan terms. It might also help you get a lower interest rate. A cosigner is essentially standing between you and the lender, which means that they will be the ones to pay back your debt if you can't. This makes the entire proposition less risky for the lender, which translates to a better chance of getting an auto loan. However, it can be challenging to find a cosigner for this same reason. The debt and any missed payments will affect your credit score as well as your cosigner's.
Check Out a Buy Here Pay Here Car Dealership
With this type of car dealership, you find the vehicle that you want to buy on their lot and then get it financed at the same place. This is different from using a third-party auto lender to finance the vehicle. Your loan approval is coming from the very same party that is also collecting the profit on selling you the car. This often makes them more likely to finance car buyers with low credit scores. However, despite presenting a solid option for those with poor credit, there are some negatives to consider. Interest rates in this scenario are typically quite high. The dealership may also stipulate that you pay in person, which makes it necessary to only consider car dealerships in your area. If you miss any monthly payments, the dealership is often highly motivated to repossess the car. Another problem is that dealerships with this program do not usually report to credit bureaus, which won't help you build credit.
Second Chance Car Loans
Another option to look at is a second-chance car loan. These are loans specifically aimed at those with an adverse credit history. If you apply for a conventional auto loan and are turned down, you can try a second-chance lender. These lenders will almost always present options with a guaranteed approval rate. Again, there are some negatives, such as high-interest rates and tacked-on fees, but the purpose is merely to provide you with another option when all else fails.
Consider Your Credit Union
If you are already a member of a credit union, you might consider checking with them for used or new car loans. Even if you're not, you might look into credit unions in your area. Start by looking at the ones associated with your employer or if you belong to any specific organizations. Credit unions are known for working with poor credit car buyers as well as offering good loan terms and low-interest rates. If you can get pre-approved for a loan before going to a car dealership, then your negotiating power will be higher.
Credit Impacts of an Auto Loan
Auto loans are one of the recommended types of loans to improve poor credit, especially for people coming out of bankruptcy. The reason is that they are installment loans, which means that you make a fixed monthly payment over a set amount of time. This type of loan can have a better impact on your credit score vs. credit card debt. When you get an auto loan, it will be reported to the three major credit bureaus in most cases. As long as you make your payments on time, this will typically raise your credit score fairly quickly. On the other hand, missed payments will quickly lower it. Too many missed monthly payments, and you run the risk of your car being repossessed.
Using a Personal Loan to Buy a Car
Most financial experts caution that this should be one of the last resorts that you use in trying to finance a car. For one thing, the loan amount for personal loans is typically much lower than for auto loans. Interest rates are often higher, and approval is usually more difficult when there's no collateral. Auto loans are specifically designed for financing a vehicle, and auto loan rates are generally lower. Even poor credit auto loans can have lower rates than personal loans. One of the reasons people consider personal loans for financing a car is due to no down payment or vehicle restrictions. It might be something to seriously think about if you are looking at a used car that costs less than $10,000 and you have exhausted all other options.
How To Get a Better Loan Rate
One thing to remember is that even if you end up with a high-interest rate loan, it doesn't need to be permanent. If you can make your monthly payments on time while also reducing the rest of your debt, your credit score may improve quite quickly. If it takes a jump into good credit territory, then you can refinance your loan to get a better interest rate. You have a few options if you decide to refinance when your credit rating improves. You can contact your current lender and find out if they will give you a lower interest rate, or you can do the same research you did before and check loan terms and interest rates with other lenders. Be thorough and check credit unions, banks and online lenders. Along with an improved credit score, an improved financial situation can help as well. For example, if you now have a higher paying job or if you got a raise at your current job that increased your total income.
Top Ten Tips on How to Get a Car Loan with Bad Credit:
Clean up your credit report as best you can before applying for a loan or going car shopping.
Check the average interest rate before car shopping to get an idea of what you might be facing. You should be wary of any rate that's double the average, even with bad credit.
Get a good down payment. Bad credit history and high-interest rates will limit the total amount of car you can afford. A reasonable down payment can offset some of this.
Know what you can afford. You might be tempted to stretch your monthly budget to afford a better car, but that car payment can come back to bite you if it reaches too far. The amount you can afford is typically the money you have left over after paying current bills and necessary expenses.
Get pre-approved. It's almost always better to go car shopping with a pre-approval rather than trying to get approved on site.
Look at nonprofit agencies. Some states have programs to provide car loans or vehicles to car buyers with low income.
Be careful with buy here pay here dealerships. As previously mentioned, these car dealerships can provide a last-ditch option, but they also have pitfalls in being overpriced and selling low-quality vehicles. Many of them take advantage of car buyers with poor credit.
Read loan application paperwork carefully. If the terms line up with what you agreed to, then you can sign. Be careful of dealerships that let you drive off without signing. A common tactic is to change the terms and have you come back to sign.
Don't buy in hopes of trading for a new vehicle. When you do this, your old balance will be added on to your new balance, and you could end up underwater quickly.
Beware of scams. Unfortunately, poor credit history can make you a big target for scams. Many predatory lenders and dealerships take advantage of people with bad credit.