December 9, 2023

Car Auto Finance

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Bad Credit Car Loans: Everything You Need To Know

Bad credit loan paperwork

Quick Facts About Bad Credit Car Loans

As times get tougher and a paycheck doesn’t stretch as far as it used to, falling behind on payments becomes more common. There is only so much belt-tightening you can do, right? As your credit history becomes cluttered with missed or late payments and maybe even a repossession or two, your credit score will suffer. And, if you suddenly need to buy a car in the throes of all this bad news, you will face a rougher road to getting a car loan. Depending on how low your credit score has tumbled, you may have to roll up your sleeves and get more creative.

As we work through this issue, we will shed some light on what a bad credit score is. Beyond that, we’ll tell you how to secure your credit score and report, and also give tips to those with weak credit for finding lenders willing to work out loan terms. Moreover, we’ll supply some ideas on getting your credit score into better shape. That’s a lot of ground to cover, so let’s get started.

What Is a Bad Credit Car Loan?

A bad credit car loan is one engineered for those dealing with financial difficulties with a credit score below 600 and a dinged-up credit history. It doesn’t mean you can’t secure an auto loan with that score, but it will certainly be more challenging to do so. Some lenders are willing to take a chance on borrowers with low credit scores; however, finding them and convincing them to take the leap requires some effort.

The biggest difference that is consistent between a bad credit car loan and a car loan to someone with good credit is the interest rate. Yes, there may be other differences from lender to lender, like larger down-payment requirements, but the one constant is higher interest rates for bad credit loans. In other words, the lower your credit score, the higher the interest rate. We explain this in more detail below.

What Is a Bad Credit Score for a Car Loan?

So, what is a bad credit score? There is no hard and fast rule for determining exactly where the dividing line is between a good credit score and a bad one. However, no matter the credit-score model – and there is more than one – any score below 650 triggers noticeably higher interest rates, closer scrutiny of your credit history, and sometimes higher down-payment requirements. A credit score below 600 will undoubtedly make getting an auto loan more complicated and expensive.

The two most often used credit scoring models are VantageScore and FICO. Both display their scores in a range of 300 to 850. However, they segment that range differently to evaluate a borrower’s credit status. Moreover, many lenders use their own internal formulas when rating borrowers according to their FICO or VantageScore number. As a rule of thumb, most lenders look more favorably on borrowers with a credit score of 661 or higher. According to the consumer credit experts at Experian, 661-780 is Prime, and scores in the 781-850 range are Super Prime. In the third quarter of 2022, the average credit score for financing a new car was 738. It was 678 for used car financing.

Lenders typically look at other factors over and above your credit score. For example, they also consider the borrower’s length of employment, home ownership, length of time at their current address, level of debt versus income, and so forth. If all those aspects of your credit health look good, a weak credit score isn’t as big an issue.

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What To Consider When Getting Car Loans for People With Bad Credit

When pursuing a car loan with weak credit, you must come to grips with two absolutes. First, you are going to be saddled with a higher interest rate. Second, you will probably need a substantial down payment.

What Are Car Loan Interest Rates?

In essence, the interest rate is what the lender charges the borrower for using its money. You will see the rate expressed as a percentage. For example, 4.5% APR (annual percentage rate). The higher the percentage, the more expensive the loan. The interest rate is based on how much the government charges financial institutions like banks, credit unions, and other lenders to access the money. As the government raises its rate, lenders must raise their rates accordingly. However, there is more to it than that. Lenders also base the interest rate you’ll pay on the level of risk they think you pose. The more banged-up your credit history is, the greater risk you represent. The weaker the credit score, the bigger the risk.

In the third quarter of 2022, the average interest rate for Super Prime (781-850) borrowers was 3.84%. For Subprime (501-600), it was 10.11%. It was even higher for Deep Subprime (below 500) at 12.93%.

What Is the Down Payment on a Car?

Risk is also the primary reason a lender demands a down payment from a potential borrower. A down payment is the amount of skin you have in the deal. Historically, borrowers who have made a sizeable down payment are less likely to default on payments because they are invested in the loan. In the case of a car loan, they are less likely to default on the loan agreement because they face losing the car and also forfeiting whatever money they initially put down. Moreover, the lender’s financial loss won’t be as significant because it received a sizeable chunk of the car’s original value as a down payment. If your credit is weak, a larger down payment will provide the lender with additional confidence you will make the payments as agreed. Furthermore, you may even score a lower interest rate if the down payment is large enough.

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Person looking at poor credit score on mobile phone

How To Get a Car Loan With Bad Credit

Here’s the good news: You can probably secure a loan even with a weak credit score. The terms of the loan might not be ideal but if you are desperate to finance a vehicle, the odds are that you can find a lender. According to Experian, more than 10% of all car loans in the third quarter of 2022 were financed by buy-here, pay-here (BHPH) car lots or other untraditional lenders. Borrowers with credit scores between 501 and 600 represented nearly 14% of all loans and leases of new and used cars. Borrowers with credit scores below 500 were 2% of the lease and loan markets.

Check Your Credit Score

A credit score is a snapshot of your creditworthiness at any given moment. It can change for the good or the bad from one day to the next. Before embarking on your quest for financing, you must know your credit score. By law, you are entitled to a free credit score from each of the three major national credit bureaus: Experian, TransUnion, and Equifax. We recommend you get one from all three bureaus. Your score may differ from bureau to bureau.

While you are at it, also request your free credit report from each. Ensure all the information on each credit report is correct because mistakes can appear. Each bureau has a process for reporting errors in your credit report to have them corrected.

How To Improve Your Credit Score

You may be able to boost your credit score by several points rather quickly by taking care of a few issues on your credit report.

  • Correct any negative mistakes
  • Pay off all balances in collection
  • Catch up on any delinquent payments

Determine How Much Car You Can Afford

Good advice for anyone shopping for a car is to calculate exactly how much car you can afford. This is even more critical when you have weak credit. Simply don’t shop for more car than you need. And remember, you need to budget for all the ownership costs, such as fuel, insurance, taxes, maintenance, and so on. Keep the cost realistic. A lender is more likely to finance an affordable entry-level car than an expensive one.

Accumulate Cash

In case you missed it above, you will need a down payment to get a loan with a weak credit score. The task may seem impossible if you struggle from paycheck to paycheck; however, the bigger the down payment, the more likely a lender will take a chance on you.

Shop Lenders

Tip: If a lender turns down your application for financing, always ask the representative this question: What would I have to do to qualify for this loan? There isn’t much you can do about bankruptcy or repossession in your credit history. However, maybe a bigger down payment or paying off a debt in collections would do the trick. In any case, the answer may help you in your next attempt.

You must exhaust all options in your hunt for a car loan if you have bad credit. Banks, credit unions, finance companies, BHPH, and any other legal lender you can find. Even if a lender offers to prequalify you for the loan, take the information and check out another lender or two. A better financing deal may be around the next corner. Every fraction of a percentage point you can shave off the interest rate will save you money.

If your credit score is at least 600, check out the financing offered in the dealership business offices. No one will be more motivated than the business manager at a dealership. It’s likely whichever brand the dealer represents has a captive financing company. This is a company owned by a car manufacturer, like Ford Motor Credit. However, in addition to the captive financing company, most dealers have several smaller lenders on speed dial. Those lenders may have more relaxed requirements than the typical bank or credit union.

Find a Co-signer

Generally, we think having a co-signer is a bad idea for you and the co-signer, but sometimes you are forced to go with the best bad idea. A co-signer is someone with solid credit who guarantees the loan. That is, the co-signer will assume the payments if you don’t or can’t make them. This situation often puts a real strain on your relationship with the co-signer, especially if you start missing payments. We advise avoiding a co-signer if possible.

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Bad Credit Loans: Lenders That Make Them

As a borrower’s credit score drops, the avenues for securing a loan begin to evaporate. As stated above, lenders also consider other factors when evaluating a borrower. If you are strong in at least most of those areas, a weak credit score loses some of its negative impact. In other words, some lenders may consider you less of a risk than your credit score indicates. The list of lender types we provide below runs the gamut. In your search for a bad credit loan, you should begin your search at the top of the list and work your way down.

  • Your bank or credit union – If you currently have an account with a bank or credit union, that should be your first stop in securing a loan. Because you are an account holder, they will likely share information with you. If you do get prequalified, you will also have a baseline interest rate for comparison as you work through your alternatives.
  • Online financing – The Internet is a sea of online lenders. Some even specialize in bad credit loans.
  • Car dealerships – Although we often think of dealer financing in terms of its brand’s captive financing arm, every dealership also has relationships with smaller lenders with less rigid requirements. This is especially true for used car dealers.
  • Finance companies – These are businesses specializing in loaning money. Lending is all they do. The interest rates are typically higher than a bank’s; however, they are in business to make loans.
  • Buy-here, pay-here dealerships – These are used-car dealerships that finance the sales they make. That is, it’s a dealership and lender rolled into one. The interest rates will be much higher than with a conventional lender, but the financing requirements are significantly looser. Often you must return to the dealership every two weeks or monthly to drop off the payment. Furthermore, they usually don’t provide much wiggle room if you are late with a payment. Tip: If you choose this option, try to do it with a dealer that reports its BHPH loans to a credit bureau. That way, you’ll earn credit for making the payments on time.

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