Simply, a bad credit auto loan is a financing solution tailored to drivers with lower credit scores. To get the best rate when taking out a bad credit auto loan, shop for a lender that offers competitive loan terms to borrowers with past credit mishaps. Avoiding costly but common bad credit auto loan pitfalls is equally important.
What a bad credit auto loan is
A bad credit auto loan is an auto loan granted to borrowers with low credit scores. Drivers with credit scores of around 580 or lower typically have a history of financial difficulties. They are considered a higher risk of default, and lenders may be hesitant to offer an auto loan with favorable terms for borrowers.
How bad credit auto loans work
You can still qualify for an auto loan when you have bad credit. And in many ways, bad credit auto loans work much the same as auto loans for drivers of any other credit bracket.
The lender will consider your credit score, income, current debt load and financial situation alongside the make, model, age and condition of the vehicle you’re interested in. Based on this information, the lender will determine the maximum amount you’re approved to borrow. They will also calculate the monthly payment based on the interest rate you’re eligible for.
How much you can borrow
Your credit score can significantly impact the amount you can borrow. Because lenders see borrowers with lower credit scores as riskier, they are often less likely to approve larger loans.
If you’re looking to get a high-end vehicle but can’t get approved for the full amount, try checking out older model years. Buying certified pre-owned can eliminate some of the risks of buying used.
Steps to getting a bad credit auto loan
A lower credit score doesn’t mean you won’t be able to get an auto loan. Try these steps to improve your chances of getting the best deal available.
1. Improve your credit score
Your credit score plays a huge role in determining what type of loan you can get — and the higher your credit score, the better your loan terms.
If you can afford to hold off on purchasing your car, take small steps to improve your credit. Paying down existing debts and bringing any past-due accounts current can make your credit score look more favorable to lenders.
Don’t forget you can review your credit report for mistakes and file disputes with the major credit bureaus — Experian, TransUnion and Equifax — to have them rectified. Corrections may take up to 30 days, so it’s worth checking well before you’re ready to buy.
2. Shop around
Don’t limit yourself to just the car dealership for auto loan financing. Apply for prequalification with the lenders that you find and compare both the rates offered and how much total interest you’ll pay. Go to your local banks and research online lenders. If you’re a credit union member, schedule a meeting with a banker at your credit union to discuss your situation and see if they’d be willing to lend to you based on your existing relationship.
Make “buy here, pay here” dealerships and bad-credit dealers your last resort. They typically offer worse terms than other types of financing.
3. Be prepared to pay more
Low credit scores come with a higher interest rate. On average, consumers with bad credit pay 12.84 and 20.43 percent in interest for new and used car loans, respectively, according to Experian’s most recent State of the Automotive Finance Market Report. This amount drops to 4.03 and 5.53 percent for borrowers with good credit.
4. Consider adding a co-signer
If you can find a friend or relative with a solid credit score to co-sign an auto loan for you, the cost-savings will likely be substantial since you’ll have access to better loan terms. You’ll also have greater approval odds when shopping for an auto loan.
Be mindful that the co-signer will be on the hook for the auto loan payments if you fall behind, which could negatively impact their credit score and financial health. Only enter intoa co-signer arrangement if you’re confident you can uphold your end of the agreement and make timely loan payments.
5. Take your time
Taking your time is also important when shopping for your car. Search current listings and compare prices at different dealerships to ensure you get the best deal.
Although the market is starting to slow down, it’s still a tough one. You may be unable to find your ideal car at a great price immediately. It may be worth stretching out the car shopping process. Most preapprovals last for 30 days, so you can take your time.
How to avoid bad credit auto loan pitfalls
The best way to avoid bad credit auto loan pitfalls is by doing a little research and determining how much car you can afford before even visiting a dealership. Be honest with yourself about your budget, and be sure you can afford the payments.
Don’t assume you’ll qualify for the best interest rate
The most desirable rates are reserved for borrowers with excellent credit scores. You will face much higher rates if you have a credit score in the 500s. If you can hold off on purchasing a car, you may be better off working on improving your credit to qualify for a lower interest rate.
Don’t assume all dealerships will offer a bad credit auto loan
Some dealerships will refuse to sell you a vehicle if you have bad credit. And don’t count on all dealerships offering the same financing options: some will have more flexible options than others. And if you come in with a preapproved auto loan, they may be willing to match or beat the other lender’s offer to earn your business.
Don’t take the longest term available, if you can help it
A longer term results in a lower monthly payment, but it also means a more expensive loan overall. Furthermore, some lenders will charge you a higher interest rate if you opt for an extended repayment period. So it may be worthwhile to choose a shorter loan term if you can afford the higher monthly payment.
The bottom line
If you’re looking to buy a vehicle, it’s critical to understand your credit and what you can expect to qualify for. But it’s not just your credit score that will determine if you get a loan. The financing options available will vary, and it’s important to shop around.