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Have bad credit? Not to worry, there are plenty of opportunities to get an auto loan, even with a less-than-stellar credit history. Finding a reputable lender offering good terms can be tricky, though. With a low credit score, you’ll likely pay a higher interest rate and there could be extra fees. Here’s what you need to know about choosing a car loan when you have bad credit.
How to tell if you have bad credit
If you’ve applied for credit cards or a loan and been denied, there may be a problem with your credit. A subprime credit score generally falls below 669, according to the credit reporting bureau, Experian. With a FICO score below this level you may not be eligible for credit products with the lowest interest rates and fees.
The FICO credit score ranges are as follows:
- 800-850: Excellent
- 740-799: Very Good
- 670-739: Good
- 580-669: Fair
- 300-559: Poor
Every lender has its own approval criteria. There are many factors in addition to your FICO score that go into the loan approval process, including debt-to-income ratio, your employment status, and whether you have an established relationship with the lending institution where you are applying for the loan.
If you have bad credit there are a variety of outcomes that could happen when you apply for an auto loan:
- Your application may be denied. If you are denied for credit, the lender has to provide you notice in writing that explains the reasons for the denial. Federal law entitles you to a free copy of the credit report the lender used to make their decision.
- The lender may require you to provide a large down payment or get a cosigner to be approved for an auto loan.
It’s important to know your rights if you think you have bad credit. You are entitled to a free copy of your credit report from each of the three major credit reporting agencies once every 12 months. Visit annualcreditrreport.com to see what’s in your credit file. If you have accounts in collections, judgments, repossessions, foreclosures, or late payments, your credit suffers.
What you may not know is that lenders from different industries use different versions of your credit score to assess your creditworthiness. Auto lenders, in particular, pay special attention to your payment history on other auto loans.
Auto lenders look at your FICO Auto Scores which are different from your simple FICO score. It begins with your base FICO score. This is the score that you see when you check your credit.
In addition to the base score, auto lenders also look at how likely you are to pay back an auto loan, based on your previous vehicle debt history. The FICO Auto Score gives lenders information like:
- Late payments on previous or current auto loans
- Repossessed vehicles
- Personal bankruptcy that included car loans
- Collections on auto loans
- Auto loans or leases you have paid off and settled
FICO Auto scores range from around 250-900.
Unfortunately, your free credit report doesn’t provide FICO credit scores that auto lenders use to determine whether they’ll approve your application. For access to FICO Auto Scores, you’ll need to purchase a different report called the FICO Auto Scores for $59.85. You should choose FICO Auto Score options 2,4,5,8, or 9 to get a clear idea of what auto lenders see on your report.
Types of auto financing loans for those with bad credit
Most car buyers require some sort of financing to purchase a vehicle. Before shopping for a car, carefully explore your options for financing so you can get the best possible interest rate and terms.
Credit unions and banks: Most banks can offer you a preapproval without being a member there, but you’ll need to be a member of most credit unions to get preapproved for a loan. If you are already a member or have a relationship with a bank, check with them to find out if they offer auto loans for bad credit. They may have programs to help their credit-challenged customers and since you already have a relationship there, they may be able to help you find a better deal. You can also comparison shop rates at other banks and credit unions. You can check out a list of recommended auto loans and banks, here.
Dealers: Many dealerships work with car shoppers who have less-than-great credit. It’s smart to go into a dealership’s finance and insurance (F&I) office armed with other financing options so you can negotiate the best possible loan terms. Talk with the F&I manager about manufacturer incentives, discounts, and rebates that could help lower the price of the vehicle.
Finance specialists at car dealerships may inflate the value of a vehicle to help subprime borrowers get approved. They also may add percentage points to the interest rate offered by the financing company in exchange for a kickback of part of that extra profit. This is known as a “markup.” While it’s technically legal, it’s a grey area and you should pay close attention if you think that a dealer is marking up your rates or value. It’s important to seek preapproval and research financing options separate from a dealership to maximize your options. Negotiating the terms of your loan is just as important as negotiating the price of your car.
Online lenders: Shopping around online can be a good way to find a better auto loan rate when you have bad credit. Be sure to limit the timeframe to less than one month, though. Each time a lender pulls your credit they can choose to do a hard or soft inquiry. Hard inquiries can lower your credit rating further while soft inquiries do not. There are many online lenders specializing in auto loans for bad credit, so pay close attention to the fine print to get the best deal and protect your credit.
Online lenders like RoadLoans offer loans for subprime borrowers.
Subprime auto financing companies: Be especially cautious when exploring this option. This type of lender may offer to finance 125% of the car’s market value, meaning borrowers will immediately owe much more for their car than it’s worth. High-interest rates, prepayment penalties, and origination fees can drive the debt up even further. Subprime auto lenders like Westlake Financial offer these kinds of loans.
Use an auto loan calculator to determine how much money you can spend on a new or used car. It will help you incorporate important details like sales tax, title and registration fees, and your trade-in value.
Five tips for securing financing with bad credit:
- Preapproved loan: Getting preapproved for a car loan online will give you leverage at a car dealership and make shopping for your vehicle simpler. You’ll know your interest rate and terms and can determine whether you can afford the monthly payments plus ongoing costs of ownership like insurance, maintenance, and registration fees.
- Consider a cosigner: If you are sure you can afford the payments and you have a cosigner with good credit willing to take the risk of adding their name to your debt, you may have a chance of getting an auto loan with better terms by applying with a cosigner.
- Pay in cash or part cash/part credit: If you have the cash to buy a car outright, doing so could save you hundreds, if not thousands of dollars in fees and interest. Making a large down payment may also help you negotiate a better interest rate on your auto loan.
- Negotiate with the dealer: Once you get preapproved for an auto loan you can negotiate better loan terms with the dealer and get them to compete for your business. They may have some flexibility with the interest rate or terms of the loan, so bring your preapproval document and ask if they can match or beat that offer.
- Wait to buy and build your credit: If waiting is an option and you can put off purchasing a vehicle for a few months, do so. Bring past due accounts up to date and make all payments, on time, going forward. If possible, reduce your total credit utilization to below 30% of your total available credit across all of your cards to increase your credit score.
How to rebuild your credit
While bad credit won’t necessarily keep you from getting a car loan, you’ll pay less in fees and get a lower interest rate if you work to rebuild your credit before applying for an auto loan. There are certain things you can do even while you look for financing that will help you improve your credit scores.
Your payment history is a crucial part of your overall credit picture. Make sure you pay your credit card bills and make all loan payments on time every month. Over time, making every payment on time will improve your credit score.
Credit utilization ratio on revolving accounts is the percentage of available credit across all credit cards that you’ve used. According to MyFICO, this number determines 30% of your credit score.
Reducing your credit utilization ratio by paying down your credit card balances to less than 30% of your total available credit across all your revolving charge accounts will help your credit score in a shorter amount of time. Credit card companies typically report to the credit bureaus once each month, so it may take a few weeks for you to see your new lower balances reflected on your credit reports.
Check your credit. Get in the habit of getting your free credit reports from each agency and check them carefully for mistakes. Removing inaccuracies could help raise your FICO scores.
Register for Experian Boost to see if your bank participates in this program. You may be able to raise your Experian credit scores by allowing the credit reporting bureau to access information about your payment history with utilities, rent and your phone bill.
Consider a secured credit card. If you need to build a positive payment history, consider getting a secured credit card. This type of credit card works to help people who don’t have a credit history or who have had past credit problems build a positive payment history with the credit bureaus. Applicants are required to provide collateral in the form of a cash deposit. The credit limit of the card equals the amount of the deposit. The card works just like a regular credit card. Secured cards charge interest on purchases, like any other credit card.
Look for one that doesn’t charge an annual fee and transitions to an unsecured account automatically after a set amount of time when you make all payments before their due date. With a good payment history, the bank may increase your credit limit on a secured card without requiring an additional deposit.
The Capital One® Secured Mastercard® has a low refundable security deposit of $49, $99, or $200. The DCU Visa® Platinum Secured Credit Card has a lower APR than most secured cards at 13.50% Variable.
Make on-time payments. After you get auto financing, be sure to make every auto loan payment before the due date. This will help you avoid late fees and penalties and it will boost your credit scores over time, making it easier for you to get approved for low interest and low fee credit products in the future. This type of loan will also help add diversity to your credit file, which helps boost your credit scores.
What is the best auto financing option for you?
Unfortunately, there isn’t a one-size-fits-all answer for auto financing when you have bad credit. While credit challenges don’t typically prevent someone with a steady income from getting financing, it’s crucial to consider the total price of the car including financing costs to determine whether you can afford to buy a new or used vehicle, or whether you can afford the lease payment on the car you want.
Use an auto loan calculator to help evaluate various scenarios. Proceed with caution. Not every bad credit auto financing offer is in the best interests of the borrower. In fact, many drive consumers with credit problems deeper into debt and cause further harm to their credit scores.