How to Buy a Car with Bad Credit

According to the credit analysts at Experian, consumers who have fair and bad credit scores have just as many car loans as those with higher scores.^[1]

Bad credit doesn’t have to keep you from getting the car you need. Millions of car buyers with credit issues get financed. The tradeoff is that you could need to put more money down, pay a higher interest rate, or face higher fees.

Here’s everything you need to know about how to buy a car with bad credit.

Table of Contents

What is a good credit score to buy a car?

Unlike buying a home, there is no minimum credit score requirement for buying a car. So, there’s is no one ‘good’ score to buy a car. Even with a credit score below 400, you can find someone that will give you financing.

However, having a lower score means you’ll pay more for the loan. Credit scores can range from a low of 300 to a high of 850.

What credit score do you need to get the best auto loan?

An ideal score to have when buying a car is anything above 750.^[2]

• Consumers who have a 750 or higher rating qualify for the best rates and incentives.
• Next on the scale are consumers who have scores from 700-749. While they don’t get the best rates, they still get excellent rates and financing because they are considered low-risk. After that, you have consumers who have scores ranging from 600-699. Because they are riskier, their interest rate is higher.
• Finally, you have consumers with “bad credit,” below 600, often called sub-prime borrowers. Lenders see this group as the riskiest, and their rates are generally the highest. But even this group is sought after by some lenders.

There are lenders that want car buyers with bad credit

If you want to buy a car with bad credit, there are lenders that are looking for your business. Both car dealers and lenders genuinely want your business and have a lot of financing available.

Car dealers want to sell vehicles, which means getting as many people financed as possible. They also make money by offering financing and may make even more money on financing people with poor credit.

Subprime buyers are a huge group, and lenders see your bad credit as their opportunity. Of course, that’s because you’ll pay them more to get finances.

How do lenders determine interest rates?

When lenders set interest rates (APR), they consider how risky each group of borrowers will be. People with good credit are less likely to default or not pay their loan back, while people with bad credit are more likely to default.

Thus, if you have bad credit, you should expect the rate on your auto loan to be much higher as this table shows.

Average car interest rates for bad credit compared to good credit

Options for getting a car loan with bad credit

Whether you have great credit or poor credit, you always want to shop for your auto loan before you start shopping for your car.  While many people understand that you can negotiate the price of a car, far fewer realize that you negotiate the financing as well. The first step is to get pre-approved for a loan, so you’re in the best position possible to negotiate.

You can find auto financing from multiple sources including:

• Banks – Don’t overlook the “traditional” bank that you currently have a relationship with. They may better understand your needs.
• Credit Unions – Credit Unions are nonprofit lending institutions, that serve their members. They often offer lower interest rates at more flexible terms to members and even sometimes non-members.
• Online Lenders – Online lenders often have specializations; find one that specializes in bad credit car loans.
• Peer-to-peer lending – Peer-to-peer lending are groups of small investors or community members willing to lend to buyers. There are a few groups that work with challenged credit. Similar groups may be able to work with buyers who have religious objections to typical banks.
• Friends and Family – If they are willing to work with you, you may be able to borrow all or part of the costs of a car. Be sure and write down the exact terms so everyone is clear. Someone close to you with good credit may also be willing to co-sign the auto loan for you, which would allow you to qualify for better financing. Just keep up with the paments or you’ll ruin their credit, too.
• Car Dealerships – Car dealerships make money when you use the lenders they represent to get a loan. But before you say yes to the dealer, check everywhere else first. You want to walk onto the lot with a financing offer in hand.

What is a subprime loan?

The Consumer Financial Protection Bureau says subprime credit scores range from 580-619, with deep subprime below 580.^[4] Borrowers with a credit rating in the subprime range or below will typically be offered subprime loans. These loans, as mentioned earlier, may require a higher down payment, will certainly have higher interest rates, and may have extra fees.

You may also have to provide extra paperwork during the application, including income or employment verification that is more than what is usually required.

Subprime loans cost you more because your lower credit score represents a higher risk to lenders.

Don’t get trapped by a predatory loan

One huge mistake that people with bad credit make when buying a car is getting trapped in a predatory loan.

These are loans that have such unfair terms where it will be difficult if not downright impossible to pay them back.

For instance, you see used car lots that tout “guaranteed approval with no credit check.” But the loan they offer you has such a high-interest rate that even making all your payments on time doesn’t pay down the balance.

As you’re shopping, watch out for these signs of predatory loans

The ugly truth behind buy-here-pay-here dealerships

Used car lots that promise to finance everyone are also called “Buy-Here-Pay-Here” car dealerships. These are the places that have signs touting “guaranteed approval with no credit check.”

Knowing they have a captive audience, they often charge exceptionally high rates and may not even report positive payments to credit agencies. They will be selling older cars at premium prices and install tracking devices in those cars to make repossession easier. These dealerships are the equivalent of “payday loan” stores. Plenty of dealerships offer used vehicles at much more reasonable price points and with better financing.

Predatory auto loans may leave you broke and carless

Buy-here-pay-here dealerships and some online lenders are most likely to engage in predatory practices. According to the Consumer Financial Protection Bureau, in the subprime auto loan segment, banks typically charge about 10%, while finance companies and Buy-Here-Pay-Here dealerships charge upwards of 15-20%. This leads to higher default rates and repossessions. The default rate of buyers with bad credit who take loans from predatory lending institutions and Buy-Here-Pay-Here dealers is about twice that of traditional lenders. Four out of ten buy-here-pay-here car buyers default. ^[5]

The fact is that it seems too good to be true that someone is actually giving you an auto loan, it probably is. Your desire to get a car should never outweigh your desire to avoid getting ripped off. As much as you may need transportation, it may be worth it to take a little more time to get it right.

Steps to take before applying for a car loan

If you have bad credit, it’s even more imperative that you take the right steps to get ready to buy a car.

1. Budgeting – Plan a budget so you know you can afford payments plus gas, maintenance, and insurance.
2. Saving for a larger down payment – Down payments above 20% will usually lower interest rates and raise approval chances. It also means you’ll be less likely to be “underwater” on your loan, where you owe more than the vehicle is worth.
3. Lowering debt-to-income ratio – Get your debt-to-income ratio below 36% for a higher chance of loan approval. If you focus on eliminating credit card debt, this will also boost your credit score, ensuring you get a better interest rate
4. Raising your credit score – Review your credit report to check for errors. If you find any, repair your credit to get your score as high as possible. You can also use tools like Experian boost to raise your credit score.
5. Shopping for financing first – Shop for the loan before you shop for the car and work to get a pre-approved loan. Having pre-approval will help you negotiate a lower rate and reduced fees when the dealership offers you financing.
6. Looking for a cheaper car – Borrowing costs are higher with bad credit, so stick with low-priced entry-level, safe, and reliable models. We have a guide on buying a car which may help you choose the right vehicle for you.

How a car loan impacts your credit

Shop for a loan the right way to avoid damaging your credit

Typically, applying for multiple loans or credit cards in a short time will damage your credit. So, you can’t just apply for six personal loans and then choose the one you want. However, the most popular credit scoring models (FICO and VantageScore) both make an exception for people shopping for car loans.

You can apply for multiple car loans to make sure you get the best rate. However, you are limited to finding your best rate within two weeks.  FICO is the most popular scoring model used in 90% of lending decisions and they give you a 30-day window to shop. However, VantageScore only gives you 14 days. So, it’s best to be on the safe side and shop for your loan in two weeks.

If you take longer than two weeks to shop around, then the extra inquiries could damage your score right before you apply for the final loan you get.

Paying off your loan helps your credit

When you first get an auto loan, your credit rating will typically decrease slightly, mainly because of inquiries. The new loan may also decrease your “credit age.” But, as long as you pay off your loan on time, your credit rating, all other things aside, will improve. Payment history is a large part of your credit rating, and having an installment loan is good for your overall credit record.

After your loan is completely paid off, you can expect your credit rating to decline a bit, but only temporarily. Additionally, because you’ve paid off the loan on time, you’ll have a positive record on your credit file. Positive records on your credit file stay on for ten years. And lenders love to see installment loans that have been paid on time.

When lenders see that you’ve paid one installment loan on time, they may be more inclined to approve you for another car or a mortgage. If you pay on time for at least a year, you may also consider refinancing your loan to get a lower rate. A benefit of having a car loan is that you can get back on the road to a better credit rating with on-time payments on your car loan.

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