When you have a troubled credit history, the prospect of financing a new car can be daunting.
And then you see the ads on billboards, in newspapers and all over the Internet. “No credit? Bad Credit? No problem!” This is the marketing gimmick dealers across the country use to convince subprime customers — in the world of auto lending, that means people with credit scores below 600 — they can afford the car of their dreams.
Dealers make a point of convincing consumers they can afford cars, says Bruce McClary at the National Foundation for Credit Counseling. They achieve this by focusing a customer’s attention on their monthly payment, rather than on the total cost of the car. By extending the terms of the loan, they can make it appear that the customer is saving money. In fact, they’re paying more in the long-run. The average term loan for subprime auto borrowers is 72 months, compared to 66 months for prime borrowers.
The troubling thing is that this strategy is working. According to a recent MagnifyMoney study, we found 82.6% of auto loan borrowers who took out a loan with a term longer than 5 years did so just to lower their monthly payment.
These long-term loans are rarely the awesome deal they appear to be at first blush. According to the most recent data from Experian, auto loan rates for subprime borrowers can easily reach 15.25% for a used car and 11% for a brand new car — triple the rates a prime borrower might qualify for.
The longer the loan term, the more time interest has to pile up. In fact, some borrowers find their loans balloon so much overtime that eventually they owe more than the car is actually worth.
“You’re left spinning your wheels to make progress on the loan and the car is worth less than you owe,” says Bruce McClary, spokesperson for the National Foundation for Credit Counseling.
What to do about a bad auto loan
Nearly 20% of auto loans are held by subprime borrowers, according to Experian. If you find yourself weighed down by an auto loan you can’t afford, it’s possible to get out from under it with careful planning. Here are a few tips to get you started:
Know your car’s value. You can look up the trade-in value of your car on sites like Kelly Blue Book. If the value is less than what you owe on your auto loan, you know it’s time to take action.
Avoid rolling your old loan balance into a new car loan. McClary warns against using special financing offers that claim to “pay off” your old loan when you buy a new car. Here’s what really happens: your old loan balance rolls into your new loan, creating an even bigger pile of debt.
Refinance at a lower interest rate. You may be able to refinance the original auto loan, which can reduce your rate. Use our simple tool to compare auto loan rates if you’re looking to refinance.
Keep it mind it can be difficult to qualify for a good refinancing offer if your credit is poor to begin with, which is the case with many subprime borrowers. There are some simple steps you can take to improve your credit over time. Chris Kukla, senior vice president at the Center for Responsible Lending, suggests working with a local credit union or community bank, which might have better refinancing options for shoppers with a troubled credit past.
“Some consumers assume they won’t get a loan because of their credit history,” Kukla says. “If you already have a relationship with a bank or credit union, you might discover they are willing to work with you on an auto loan refinance.”
Negotiate your loan terms. If refinancing through a different lender isn’t an option, you can try to renegotiate your loan terms with your current lender. If the lender isn’t willing to budge your interest rate, they may agree to shorten the term of your loan. Paying off your loan in larger chunks over a shorter period of time will help reduce the amount of interest you pay over time.
Sell your car. Sometimes when you’re stuck with a car that is worth less than what you owe on it, you have to cut your losses and sell, McClary says: “Sell the car, pay off the bad auto loan, and buy a less expensive car.” This will, unfortunately, still leave you with a loan balance to pay off. In that case, you can look for ways to earn additional income to help pay down the loan balance faster. Think about raising funds by selling another valuable or asking a friend or family member for a small loan. There are personal loans that can help cover remaining auto loan balance, but they can be difficult to qualify for if your credit is poor.
McClary says you don’t need to completely pay off the bad auto loan to get out of it. It’s really a numbers game: “Sometimes you just need to pay down the loan to the point where you have enough equity to qualify to refinance at a better rate.”