We’ve all seen the banners at used car lots screaming “Bad Credit, No Problem,” and “We Finance Anyone.” While it’s indeed possible to obtain a new- or used-car loan if you’re saddled with a pockmarked credit history, be aware that it may be more difficult to secure, and you’ll certainly pay higher interest rates than so called “well qualified” buyers having top-notch credit scores.
Whether it’s a car loan or a home mortgage, lending is all about managing risk. Simply put, the greater the perceived chance a borrower will default on a loan, the higher the interest rate he or she will be charged. Financing given to someone having a below-average credit score is called a sub-prime loan. If you’re in that situation rest assured you’re not alone – sub-prime financing is at its highest level since 2010, now accounting for more than 40% of all auto loans.
Check Your Credit Score
It’s a good idea to verify your current credit status before applying for a loan or heading to a new- or used-car dealer’s showroom. Some banks and credit-car providers offer this as a perk to its customers, or you can check your score online via any of a number of sources like Experian.com, CreditKarma.com, and Equifax.com, among others.
The most common source of credit scores is FICO (It stands for Fair Issac Corp., which is the system’s creator and curator). FICO scores are based predominantly on a consumer's payment history (35%) and outstanding credit balances (30%), and to a lesser degree on the length of his or her credit history (15%), recently obtained credit (10%), and the overall mix of loan types, including credit cards, and previous car loans (10%).
A FICO score of 580 or less represents "poor” credit, with a “fair” score being between 580 and 669. Consider yourself to be a subprime candidate if you score anywhere in the above ranges. The national average FICO score is 695, which falls within the “good” range of 670-739. Those having “very good” (740-799) or “exceptional” (800 and above) ratings can generally expect to be offered lender’s the lowest rates and most liberal terms.
To muddy the waters a bit, lenders will often use FICO scores tailored specifically to car buyers, which have a slightly broader range. And at that, a given lender may treat credit ratings differently according to its internal tolerance for risk. For example, a score of 730 to one institution might be enough to qualify for the lowest rates, while the bank down the street could require a score of 760 or above. What’s more, lenders will also take into consideration your annual income and how much credit you have, and take a long look at your detailed credit history to further determine your eligibility for a loan.
Have Reasonable Expectations
If your credit is sub-par, be prepared to shop for a less-costly car to accommodate what will certainly be a higher interest rate. While a borrower in good standing might pay as little as 3% as of this writing for a 60-month car loan, subprime borrowers will likely pay 10% to 13%, depending on their credit score. According to the website Wikilender.com, the difference in interest costs over the life of a $20,000, 36-month new-car loan could be nearly $5,000 (that's around $140 a month) between those having “exceptional” and “poor” credit scores.
To help make sure you’ll be able to pay off that car loan diligently, budget for the ongoing costs of fuel, maintenance/repairs, and car insurance premiums in addition to your monthly payment (and be aware you’ll probably be charged more for insurance if you have bad credit – according to NerdWallet.com the national average stands at an annual $690 increase in premiums).
Maximize Your Down Payment
Having a larger down payment will usually help obtain lower-cost financing, as the lender will assume less risk by financing a car having additional built-in equity; this helps ensure the vehicle will be worth at least as much as the loan balance, should you default. If you have a trade in, be sure to research its value ahead of time to help maximize its return, which will, in turn, boost your down payment. If you’re looking for a new vehicle, choose one that comes with a hefty cash rebate from the manufacturer that can likewise be used to increase your down payment.
Shop For Financing Ahead Of Time
No matter how your credit score stands, it’s always prudent to shop around among multiple lenders to find the lowest rates for which you’re qualified, and to get pre-approved for a loan. Call local banks – start with the one with which you have an account – or your credit union if you’re a member, and don’t hesitate to apply for a car loan via online sources.
If your credit is especially dicey and you’re having trouble getting approved by local lenders, you may have no other choice (aside from borrowing cash from a beloved relative) but to see what kind of a financing deal, if any, a new- or used-car dealership might be able to offer. A given dealer may be able to intercede in your behalf with the lenders with whom they do business, but prepare to pay dearly if your credit is especially bad. You could be asked to pay as much as 30% interest with a loan secured from a street corner “buy here, pay here” used-car lot.
Always focus on a loan’s annual percentage rate as stated in the loan agreement. Never buy a car based on a quoted monthly payment, which might be for an extra-long payment period – perhaps longer than the car you’re financing can be expected to keep running – and at an exorbitant rate of interest. Look for unnecessary add-ons like credit life insurance or extended warranties that might be wrapped into a dealer’s loan agreement. And make sure all terms are final before taking possession of the car; some unscrupulous dealers have been known to inform buyers a day or two down the road that their financing had not yet been completed and the interest rate or required down payment has increased in the meantime.
Buy A Cheaper Car
If you’re trying to buy a new car and can’t get financed, or at least not at a reasonable rate, consider buying a lower-cost used car for which you might be able to obtain a loan at more favorable terms (your down payment will represent a larger percentage of the purchase price, thus representing less of a risk to a lender). Or bite down hard on the proverbial bullet and pay cash for an older “beater” to drive while you work to rebuild your credit rating.
