With car loans accounting for over $1 trillion in debt in the United States alone, Americans are clearly buying cars quite often. In fact, recent statistics suggest that car loans represent at least 9% of the overall consumer debt market, and the average car loan payment is estimated to be around $460 per month.
Car loan payments are likely to be an important item in the budget of most American households, especially considering that they add up to nearly 9% of the median household income in the U.S., which was nearly $62,000 in 2018 according to the U.S. Census Bureau.
While these statistics show that most Americans purchase their vehicles through car loans, accessing these loans is commonly contingent on having a favorable credit situation.
The Consumer Financial Protection Bureau (CFPB), an institution that regulates financial markets and studies the evolution of different financial products and how consumers use them for their day-to-day transactions, classifies the borrowers of car loans as follows:
- Deep subprime – scores below 580
- Subprime – scores between 580 and 619
- Near-prime – scores between 620 and 659
- Prime – scores between 660 and 719
- Super-prime – scores above 720
This means that individuals with a credit score lower than 659 may not be considered eligible for a car loan through most traditional lenders. In fact, applicants with scores this low only account for 25% of the lending volume.
With this in mind, if you are currently going through a challenging financial or credit situation, we understand that it may be difficult to find funding to buy a car, and for that reason, we’ve put together this list of 12 tips for buying a car and finding a loan with bad credit.
How are Credit Scores Calculated?
Let’s first talk about the basics of credit scores to help you understand why they are a determining factor when obtaining a car loan.
Lenders use credit scores to quickly evaluate a borrower’s creditworthiness. They are calculated based on certain variables, including the borrower’s payment history, the age of their credit history, the diversity of the credit mix, and the number of recent credit inquiries they have received, among other relevant elements. These variables are weighted differently depending on their degree of importance, and these values are ultimately combined to produce a total, which is known as a credit score.
The most common credit score used by lenders in the United States is the FICO score, which ranges from 300 to 850. This score was developed by the Fair Isaac Corporation, and financial institutions use it to determine if a borrower is a suitable candidate for any type of loan.
The information required to calculate these scores is provided by credit reporting agencies, which are institutions that gather, organize, and report the data associated with a borrower’s credit accounts. This data includes the punctuality of the borrower’s payments, the amount owed on each account, the current status of the accounts, and many other data points that are ultimately presented through a comprehensive credit report.
More specifically, FICO has also developed a credit scoring model for auto loans called the FICO Auto Score 8, which incorporates industry-specific variables that allow lenders to evaluate candidates for this specific type of loan.
Lenders prefer to extend car loans to individuals with a score higher than 660 since they carry a lower risk of incurring late payments or defaulting on their debt. While you may be approved for a car loan with a credit score lower than that, there are a few aspects of your loan that will be affected if you have bad credit, including:
The Interest Rate of Your Car Loan
According to Bank of America, if your credit score is lower than 639, the interest rate you can obtain on a traditional fixed-rate mortgage typically varies from 4.354% to 5.943%. This shows how a low credit score can affect your cost of borrowing and how buying a car can be more expensive if you have bad credit, as the interest rates of your car loan will be affected similarly.
The Length of Your Car Loan
The credit term of traditional car loans typically ranges from 36 to 72 months, depending on the lender. Borrowers with bad credit, however, may face stricter terms due to being perceived as a higher risk by the lender. Some lenders may ask borrowers to repay their bad credit car loans in fewer than 24 months.
The Amount of Money Approved
Buying an expensive car with bad credit may be difficult as lenders might be reluctant to extend large amounts to individuals with a low credit score. That being said, while having a bad credit puts you at a disadvantageous position when buying a car, it is not an impossible task. The following tips may help you increase the odds of getting approved for financing.
12 Tips to Buy a Car with Bad Credit
These tips are intended to put you at a more favorable position before or during the process of finding funding to buy a car with bad credit.
Tip #1: Secure a larger down payment
The amount of money potentially offered to you by lenders if you have bad credit will probably be limited. One way to tilt the scale in your favor when buying a car with bad credit involves proposing a larger down payment.
If you’ve saved at least 30% to 40% of the price of the car, you will likely increase your odds of getting approved.
Tip #2: Pick a car that suits your financial and credit situation
Buying a brand new car with bad credit will likely involve high interest rates that could potentially be as large as the value of the car itself. If your credit situation is currently not at its best, consider shopping around for a car that fulfills your needs, not your desires. Your monthly payments will be lower, and you can use any budget surpluses to fulfill other financial commitments.
Tip #3: Work on your credit
Unless you have been the victim of identity theft, there’s no easy or fast way to fix your credit score, but that doesn’t mean you can’t start reshaping your credit situation one punctual payment at a time.
Before you start applying for car loans, you could take a few months to put your finances in order by paying your financial commitments on time. Credit bureaus report financial transactions every 45 days, which means that your score will progressively improve as your accounts continue to show up as current. You can also consider lowering your credit utilization ratio by paying your outstanding balances; the ideal credit utilization ratio for most lenders is below 30%.
Tip #4: Look around for the lowest interest rates available
Depending on your credit scores, the average interest rate for car loans may range from 4% to 20%. For individuals with bad credit (non-prime, subprime, or deep subprime), the rates are usually higher than 10%. While you can certainly get a loan with a low credit score, it may be expensive.
Use these rates to help you look around. Consider visiting local dealers, financial institutions, non-traditional lenders, or maybe even a close friend who may be willing to loan you the money at a lower rate than what lenders are offering.
Knocking on a few doors could help you save money through lower interest rates, or it could also help you in obtaining more favorable terms if, for example, certain fees are waived.
Tip #5: Try to limit the number of applications you send
Constantly applying for a loan at different financial institutions will produce hard credit inquiries that will stay on your credit report for at least 24 months. If these inquiries showed up within 12 months, they will negatively affect your overall score.
If you are looking to buy a car with bad credit, accumulating a significant number of recent inquiries could make it even more difficult as your credit score will continue to drop as new inquiries continue to show up.
If you have bad credit, reading through the minimum requirements of your financial institution, and talking to your banker or lender personally could help you in assessing your chances of being eligible for a car loan.
If you receive a positive response from them, consider applying. However, if the likelihood of your approval is low, applying may not be the wisest decision, as the inquiry will affect your future possibilities.
Tip #6: Be careful with in-house financing offered by used car dealers
Most used car dealers will offer you financing on one of their used automobiles as a way to persuade you to pick a car from their lot.
The cost of borrowing directly from them tends to be more expensive than traditional loans, as dealers are less interested in carrying the risk associated with lending money to individuals with bad credit.
The credit terms associated with this type of funding is usually shorter, and the APRs are commonly higher. Additionally, you may have to pay for several extra items to be eligible for this type of financing, including an extended-guarantee or insurance policies where the dealer serves as the intermediary.
Make sure the terms are favorable, and the cost is actually lower than what you could end up paying through more traditional channels.
Tip #7: Used your pre-approved loan amount as your starting point
If you have already browsed through the available funding alternatives, you may have been pre-approved by one or more lenders for a certain amount for your car purchase. This amount could help you when choosing the right vehicle since you can add up your available down payment plus the pre-approved loan amount to calculate the maximum price you would be willing to pay for the car.
Additionally, since the loan has been pre-approved, you can spend less time looking at options that are outside your budget. Instead, you can shortlist the ones you have already identified as good fits for both your budget and your transportation needs.
Tip #8: Bring a co-signer on board
If you have a friend or a relative who is willing to vouch for you during a challenging credit situation, your odds of getting approved for a car loan will be significantly higher, especially if that person has a prime credit score.
Your co-signer will be held responsible for the payments of your car loan in case you fail to meet your financial obligations. Still, you should make sure they understand the risks associated with co-signing if you feel you may be unable to pay on time at some point.
If your budget is actually in good standing, and you can comfortably take on the payments associated with your car loan, a co-signer can be a suitable alternative.
Tip #9: Consider non-traditional lenders
More than 30% of Americans get their car loans from their banks, which means that the first place that comes to mind when it comes to buying a car with bad credit may be applying for one at your preferred financial institution.
Unfortunately, traditional lenders often demand high credit scores and nearly-perfect credit history to get approved for a car loan, which leaves individuals with bad credit short of alternatives. Applying for a car loan at a non-traditional lender, such as a peer-to-peer lender (P2P) or a credit union, is an option you should consider if you are looking to buy a car with bad credit.
Tip #10: Try choosing the basic version of a car if you have bad credit
If you are looking to buy a new or used car with bad credit, adding extra features to it will end up increasing the amount of your bad credit loan and, consequently, the interest payments. If you really desire these add-ons, you could pay for them separately after you have completed the purchase, and preferably in cash, if you can afford them.
Your top priority is to get financing for the car itself; adding extras could significantly increase your monthly payments.
Tip #11: Desperation is your enemy
While you may think that investing time in researching alternatives is just not worth it, getting desperate could lead you to make poor decisions that could end up affecting the stability of your personal finances, including potential scams intended to lure individuals with bad credit who are looking for the best bargain.
If you feel compelled to do business with a non-traditional lender, make sure you research them to confirm that their offering is sound and legit. You could look them up on the Better Business Bureau (BBB) website to check if they have received a significant number of claims or negative reviews, or you could also ask to see their lending license to operate in the state where you reside.
Tip #12: Do you really need a car right now?
Buying a car with bad credit is expensive. Interest rates will be at least twice as high as those you can obtain if you had a higher score, and this makes them an alternative that you should only consider if you truly need to get one to fulfill your transportation needs.
Instead, consider other means of transportation, such as taking the bus or car-pooling to work, while you overhaul your credit score through consistent punctual payments. Once your score reaches a higher level, you could revise this decision to get yourself a cheaper loan that will be more budget-friendly than a costly bad credit loan.
It is definitely possible to buy a car with bad credit by browsing through the available alternatives the market has to offer. However, the cost of borrowing one is usually high, and some conditions may apply.
By using the tips described above, your odds of getting approved for a bad credit car loan should be higher, but the ultimate decision should be made based on your financial situation, and your actual capacity to fulfill the payments associated with the loan.