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Consumers with bad credit typically face some challenges when seeking a car loan. These applicants usually have fewer loan options and pay high interest rates.
Being prepared and thoroughly exploring your options is important in this process. Having proper documentation and cash upfront for a down payment are two of the most critical.
Steps to Take Before Applying for a Car Loan
Consider the following best practices in anticipation of seeking a car loan.
Check Your Credit Score and Try Improving It
Each consumer is eligible for a free copy of their credit report annually. Review your credit history for any errors that could be hindering your credit score. Although you can’t raise your credit score overnight, detecting errors is an efficient way.
The three leading credit bureaus are Experian, Equifax, and TransUnion. Remember that some lenders might only report to one or two of these bureaus. If you find any errors, submit a dispute to the credit bureau or the original creditor if necessary.
Credit report errors are more common than you might think. If your dispute is valid, your credit score might get a boost. Checking your report might also reveal fraudulent activity such as identity theft. Thus, checking your credit report regularly is a good habit.
Know How Much You Can Afford
The prices for cars in the U.S. are reaching new heights. New vehicles are selling for more than $45,000, which also drives up the costs of used cars.
Before applying for car loans, you should take a realistic look at what you can afford. This is particularly important for those with bad credit, as you will also likely face high-interest rates.
Experts suggest that the most a consumer should spend on a car is 15% of his net pay. This represents a general guideline because each person’s financial situation varies.
Avoid spending more than you can reasonably afford. Having a large car payment could result in late payments and further harm your credit.
Get a Cosigner
Those with bad credit might qualify for a car loan with much more favorable rates with a cosigner. A cosigner is another individual that assumes financial responsibility for the loan.
A cosigner is ideally someone that has a good credit history. Cosigners expose themselves to risk. Thus, most cosigners are either close friends or family members.
Bear in mind that some lenders might not allow cosigners for their auto loans.
Show That You Can Afford Car Payments
Prospective lenders will want to ensure that you have enough income to repay the car loan. You should have documentation that verifies your employment and income.
Those with bad credit should expect scrutiny regarding their employment history and income. If applicable, bring documents showing other income, such as child support.
Some lenders use detailed metrics when assessing affordability. One such example is your debt-to-income (DTI) ratio, a percentage calculated as follows:
DTI = Sum of all monthly payments / Monthly gross income
Estimates vary, but lenders will express concern when your DTI exceeds 40%. A DTI of 50% or more is often unmanageable and makes you vulnerable.
Get Pre-Approved for a Loan
Obtaining a pre-approval for a car loan might benefit borrowers with bad credit. Banks, credit unions, and other direct lenders are possible options for getting pre-approval.
For borrowers, a pre-approval is also useful because it gives you a realistic budget. With bad credit, lenders are often hesitant to extend large loans.
Keep in mind that a “pre-approval” and a “pre-qualification” are often different. With a pre-qualification, lenders may perform a “soft” credit check and provide an estimated loan amount and terms.
With a pre-approval, lenders usually perform a “hard” credit check and definite terms.
Check with banks or others that you have an existing relationship with first.
Make a Bigger Down Payment
Having some money upfront for a down payment is a good idea, particularly for those with poor credit. Most lenders will require those with no credit or bad credit to have one.
A down payment reduces the total amount that you are financing. Further, a down payment reduces the amount of interest you pay and the monthly car payment.
Having a 10 to 20% down payment is usually recommended. With auto dealers, borrowers with an existing vehicle may trade in that car toward their down payment.
Options to Get a Car Loan With Bad Credit
Subprime auto loans are the type usually offered to borrowers with bad credit. Subprime loans feature high-interest rates that lenders impose to offset their risk.
There is no official or standard minimum credit score associated with subprime loans. Yet, consumers with a sub-600 credit score are likely subprime borrowers. The following table summarizes the subprime market.
Car Loan Rates By Credit Score
|Credit Score Range||Average APR|
|Deep Subprime: 300-500||20.62%|
Source: Car Loan Rates
Direct dealer financing is usually termed as “buy here, pay here.” The traditional BHPH dealer is a smaller, independent, used-car lot. Yet, regional and national dealership chains also now exist in the market.
These dealers might not even check credit scores. The loans offered at BHPH are notorious for having high-interest rates and fees. Often, these dealers have a somewhat limited selection of vehicles.
Dealers who finance car loans themselves often don’t report to the credit bureaus. This is a potential concern for those expecting to build credit through their car loan.
The BHPH dealer route is often unfavorable in many ways. But those who need to finance a vehicle might find themselves without other options.
Bad Credit Auto Lenders
Most auto dealerships facilitate loans for their customers through lenders. Dealer-arranged financing may have some advantages for those with bad credit.
The finance department at an auto dealer likely has relationships with subprime lenders. This may allow you options, as several lenders will make loan offers.
Auto dealers have a clear motivation to sell cars. Thus, you can expect that they will put forth some effort to secure financing.
One potential drawback to dealer-coordinated financing is they often “mark up” the rates. Here, the dealer factors in a small profit for themselves in the loan.
Bank or Credit Union
Banks and credit unions also often offer car loans for those with poor credit. Here, you might first get pre-approved for financing through the lender and then visit a car dealer.
If you are seeking to buy a car from a private seller, you should verify that the institution will finance it.
This arrangement may represent a good option for those with bad credit. This usually applies if a financial relationship with a bank or credit union already exists.
Those who receive pre-approval should get the financing details in writing. This may prove helpful, as you can later ask the dealer to search for a loan with better rates.
In today’s interconnected online environment, online lenders are more common than ever. Some online lenders might offer more competitive rates on car loans.
Without physical locations or branches, online lenders often have fewer overhead costs. Here, the lenders “pass” the savings along to the borrower.
What Is The Lowest Credit Score For a Car Loan?
There is no universal or official minimum credit score requirement to qualify for a car loan. In fact, the “subprime” auto loan market exists for financing consumers with bad credit.
Most of those with a bad credit score will find a lender that will offer them a loan for a vehicle. Yet, those with bad credit should expect that any loan they qualify for will have high interest rates.
Your credit score is not the only factor that subprime lenders consider. Other factors that apply include your employment status, income, and available down payment.
Can I Get a Car Loan With a Credit Score of 500?
Consumers with a 500-credit score will usually find someone willing to offer them a car loan. Yet, these loans will have high-interest rates.
One reason that those with bad credit can get car loans is that they represent a secured loan. The vehicle’s value serves as security for the lender (collateral). If the borrower fails to make the loan payments, the lender can repossess the car to offset losses.
According to Experian, roughly 16% of borrowers with an auto loan have a credit score below 600. The car loans offered to those with a 500 to 600 credit score are often classified as subprime.
Loans offered to those with a sub-500 credit score are often deemed as “deep” subprime.
What FICO Score Do Car Dealers Use?
Car dealers may use FICO scores based on calculations using various scoring models. To add further complication, the score generated may differ between credit reporting bureaus.
Equifax, Experian, and TransUnion generate your credit history report. But not all lenders submit (report) their account activity to all three. This is why differences exist based on the bureau that is reporting.
According to FICO, the versions used in auto lending include:
• Experian: FICO Auto Score 2, 8, or 9
• Equifax: FICO Auto Score 5, 8, or 9
• TransUnion: FICO Auto Score 4, 8, or 9
In 2020, FICO introduced a new FICO Auto Score 10.
What is a Good Credit Score to Buy a Car?
- What Credit Score is Needed to Buy a Car With No Money Down?
- Do Multiple Car Loan Applications Hurt Your Credit?
- How Much Does Your Credit Score Increase After Paying Off a Car?
- Can I Get a Car Loan With a Credit Score of 500?
- How Long Does a Repo Stay on Your Credit?
- My Car Was Repossessed. What Happens Next?
- How Soon Can I Get My Repossessed Car Back?
Anthony Amodeo is a regular finance writer in both business-to-business and business-to-consumer industries. Particular areas of focus include personal finance, small business, real estate, and more. He is a graduate of Kent State University. His credit scores are top tier.