Bad Credit Car Loans
What to Do When You Need a Car but Have Poor Credit
Your credit score and history affect the loan and interest rate you can get when purchasing a car. Generally speaking, the better your credit score and history, the better your options. When you are considered “low risk”, lenders—such as banks, dealerships and credit unions—trust you.
But what if you have a low credit score? Fear not; your chances at securing an auto loan are not completely hopeless.
Read on for advice about why credit matters, other factors lenders consider, and how to make your financial situation work despite the possibility of high-interest rates. (And don’t forget to take a close look at our tips about how to increase your credit score along the way!)
Who Is This Guide For?
The following are profiles of people at risk for low credit. They may be more relatable than you’d think.
The young adult
Many young adults do not have a credit history. Some may have debit cards but do not realize that debit cards are not reported to credit bureaus. Additionally, as Millennials take on school loans, they may doubt their ability to maintain a credit card and pay it off on time. Reliance on cash or digital payment services such as Venmo is now the popular alternative.
This means that with a nonexistent debt history, lenders have no way to assess whether or not a young adult is trustworthy enough to receive and pay back a loan. This makes buying a car harder; they will either be faced with high-interest rates on their auto loans or will be required to have a co-signer.
The avid shopper
The stats are in: The APR on credit cards is currently at 17.8%. Why is it so high? It is much easier to spend more than usual when you are swiping your card instead of physically handing over the Benjamins.
Credit utilization is the ratio of your current credit card balance to your credit limit. The bigger the number, the worse your score. Even using more than 20-30% affects your score negatively, and once you’ve hit your credit limit, you cannot make any more purchases. This means debt, late payments, borrowed money…and a low credit score.
The delinquent payer
When you miss payments or default on a loan, your credit score dropping is not the only repercussion. Be ready for late fees, higher interest rates, and difficulty receiving future credit.
The time between the last payment until you see signs of default is 180 days for credit cards and around 30 days for auto loans.
If you agree to co-sign a credit card or an auto loan, you are obligated to pay off anything that the borrower cannot. This is a risk because their actions can lower your credit score as much as their own score.
Why Credit Matters When Getting a Car Loan
Your credit score will determine how much money you can borrow and at what interest rate. Why? It gives lenders an insight into the history of how you manage your debts.
“Think about it this way: credit is short for ‘credibility,’” said Charles Cannon, manager at a BMW dealership in Houston, TX. “It gives a lender a snapshot of your ability to pay people back in a timely manner and [whether] you are purchasing more car than you can afford.”
Other Factors Lenders Look At
Although a high income always helps when it comes to applying for loans, what is more important is your debt-to-income (DTI) ratio. This is the percentage of your gross monthly income that goes towards paying off your debts—whether it be for a credit card, a mortgage, or a car. No matter your credit score, a solid income, and low DTI will be viewed more positively.
Lenders will also look at your savings account; you are considered less of a risk if they can trust you have enough money to make payments.
A high DTI indicates you may not have adequate money in your account after you make your monthly payments. Lenders want their loan to be high up on your list of financial priorities, so financial instability in the first place makes lenders question the risk of loaning you money.
Shopping for a car? Newer vehicles are less of a risk and have lower interest rates. If repossessed, they can still be sold at a good price. Older and/or used cars have higher rates.
Even if you think you got the best loan from your bank or credit union, bring it to the dealership and see if they can beat the offer.
The longer you wait to pay off a loan, the more interest you may accumulate in the following months. So make a large down payment upfront—especially if you have a low credit score. Shoot for 20% or more, and you and your lender will be happier in the long-run.
Ways to Boost Your Credit Score
Check your credit report for errors. The Fair Credit Reporting Act allows you a free annual credit report from these credit bureaus: Equifax, Experian, and TransUnion. Begin by visiting annualcreditreport.com. Dispute anything you find incorrect. This will require a letter, copies of your documents, and a waiting period of up to 30 days for investigation.
Pay your bills on time—or get caught up. If you find yourself unable to keep track of payment periods, set up automatic payment reminders or autopay.
Pay more than the minimum owed. This will relieve your debt quicker.
Do not open new lines of credit. When you apply for credit, your account gets labeled with a “hard inquiry”. Multiple inquiries make you look desperate and a higher risk—lowering your credit score.
Keep your car loan search within a two-week period. When a lender reviews your credit report in order to find you the right loan and interest rate, a “hard inquiry” will be attached to your report. If you shop quickly and keep inquiries low, your score will not be lowered as much.
Keep credit spending low. If you are trying to boost your credit score, using cash or debit in order to keep debt accumulation in check can help you budget and spend less money.
See a credit counselor. Through a review of your debt and credit history or even enrollment in a debt management program, counselors can help you eliminate high-interest rate debt and develop better financial habits.
Steps to Getting an Auto Loan with Bad Credit
High or low credit, the first thing you need to do when getting an auto loan is set an overall cost and monthly budget. Then check your credit report for errors, shop around and apply for auto loans, get pre-approved, find a car, and compare loan terms before finalization.
If you indeed happen to have a lower credit score, follow these additional steps to get the best possible loan:
Pay down your debt
Before applying for a car loan, lower your debt-to-income ratio (DTI). Start with your credit cards.
Compare multiple lenders
Consider the pros and cons of each lender:
Banks have competitive rates and personal knowledge of their customers, but conservative policies that deter those with lower scores from finding a good deal. Credit unions offer lower rates, but some may require membership and fees. Online lenders also have competitive rates, but prove difficult when it comes to communication and/or transfer of personal information. Dealerships are oftentimes connected through a bank; they offer loans to those with lower scores, but they may increase pricing for a profit.
Choose a short-term loan
With bad credit, your interest rates are already higher. Find a short-term loan with lower rates. They are designed to help you pay off your debt faster, even though monthly payments are higher. If you can, shoot for a 24-36 month loan.
Should you get a co-signer?
They will be liable for any failed debt payments, so a co-signer should be a trusted family member or friend with a high credit score. For example, young adults often co-sign with their parents.
If your credit is low enough for you to be considered high risk or you do not meet lender requirements alone, you may have no other choice.
Be open about vehicle type
As we learned, newer vehicles have lower interest rates. If you cannot afford a newer model, it may be best to wait and save up money until you can. Otherwise, don’t be too picky about the car you purchase—an older, used model will get you around just the same!
Add-ons are extra services that the dealership offers. They are often presented to customers in a packaged “deal”. These offers include extended warranties, theft protection, insurance—even things like fabric protection. Be careful, as these are ways for dealers to make an extra profit or increase interest.
Where to Get a Car Loan When You Have Bad Credit
Each financial case is unique, so banks, dealerships, and credit unions will still grant loans to those with lower credit. Because credit unions are traditionally more open to lending money despite low credit, you may consider putting time and research into finding a competitive rate there. Don’t forget to take whatever offer you receive and present it to the dealership—if there’s a chance of a better deal, take it!
Making It Work with a High Interest Rate
What happens when you have low credit and cannot avoid a high interest rate, but need a car? Follow these tips and you won’t default:
Refinance your loan
If interest rates have dropped, your credit score has improved, and/or your overall financial situation has improved, try refinancing your loan. This means taking on a new loan at a better deal in order to pay off the existing loan.
Boosting your score may take a significant amount of time, but you will only be able to refinance your auto loan within the first few years. Wait about one year before beginning shopping around for pre-qualifications.
Pay it off ASAP
When struggling with a high-interest auto loan, it’s better to pay it off ASAP to avoid paying more for the car than it’s worth. If you have other payments you’re working through, like credit card debt with lower interest rates, pay the minimum possible on those accounts so you can throw extra cash at your car loan.
Use your tax refund wisely
The average tax refund can climb to a few $1000 dollars. If you get one in the spring, use it as the extra cash you apply to your car payment. This will help you pay off your loan sooner. It’s often a significant amount of money people forget they’ll be receiving!
If your credit score is so low that your interest rate is unmanageable, or you feel the only vehicle you can afford is unsafe, wait a few months or a year to see if you can improve your score and qualify for something better. In the meantime, look for a reliable, temporary alternative. An added bonus? These options reduce your carbon footprint and can save you money!
Do you live near a bus, tram, or rapid transit? Depending on how far and how many modes you’ll be using, it only takes between $3-$25 a day. The American Public Transport Association claims that a family can save between $6,000-$10,000 each year by using public transportation. Remember that monthly passes are available, as well as student, senior citizen, and disability discounts.
BIKES AND BIKE-SHARING
If you live close enough to your places of work and recreation, consider dusting off the old bike! It’s both a money saver and a form of exercise. Bike-share systems are also becoming popular in towns and cities. All it takes is a small fee to rent and return to a public bike rack. Some mobile mapping apps now show where these racks are located.
Similar to bike-sharing, companies like Zipcar allow members to use a car without having to worry about car payments, insurance, car maintenance or the cost of gas—and at a low cost of $7 per month. Companies like Zipcar also offer university discounts for students and teachers. If planning to use it less often, you can simply pay for the number of hours you need the car.
TAXIS AND RIDESHARE APPS
In the city, you have access to public transportation, as well as city taxis. However, if you need to get somewhere public transportation doesn’t reach, or you live in a non-urban area, you may need to use convenient mobile rideshare services like Uber and Lyft. Keep both taxis and rideshares in mind because pricing depends on where you are and where you are going. Additionally, stay on the lookout for rideshare promos for new users or regular riders because Uber and Lyft charge a premium during peak hours. Of course, using these services regularly can add up, so don’t rely solely on these options.
On each app, Uber and Lyft also offer carpool options—uberPOOL and Lyft Line, respectively—as a cheaper alternative. Or you can go old-school: If you need a way to get to work, can a coworker give you a lift if you chip in for gas money? This should be way more affordable than a high-interest car payment and maybe even public transportation.
It’s a big lifestyle change, but it’s something you might need to consider. If the reason you are shopping for a car is due to distance, remember that all the options above may be available to you at a cheaper price if you moved closer to where you need to be.
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