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How to Buy a Car with Bad Credit

US News & World Report - Cars logo US News & World Report - Cars 9/27/2018 John M. Vincent

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You need a car to drive, but your credit history is more of a nightmare than a dream. Can you even get auto financing with bad credit? The answer is probably yes, though you’ll need to do some extra work before, during, and after you get the car loan to ensure that getting financing is a beneficial long-term move.

Research

The auto lending industry is built on trust. Lenders trust borrowers with excellent credit to pay back their loans on time more than they trust borrowers with bad credit to do so. That high risk is priced into auto loans in the form of higher interest rates plus terms that are more restrictive. If you have bad credit, car finance rates will likely be higher than if you have good credit.

If you have bad credit, “you’re probably not going to get the lowest rate possible,” says Joe Pendergast, Navy Federal Credit Union’s vice president of consumer lending.

Researching your credit history can help you secure the most affordable car financing. Your goal is to understand where any problems lie, how you can repair your credit score, and how much you can genuinely afford to spend for a new ride. You will then want to shop for the lowest price of financing by applying to several lenders, getting preapproved offers before you consider heading to the dealership.  

Unfortunately, some unscrupulous lenders prey on consumers with lousy credit. It is important to know how to identify and avoid lenders and tactics that will only make already poor credit even worse.

Once you have received auto financing, there are things you can do to make the car loan a stepping-stone to better credit.

This guide provides answers to some of the most frequently asked questions about getting a car loan with bad credit:

  1. What is Bad Credit?
  2. How Do I Know How Bad My Credit Is?
  3. What Kind of Car Should I Be Shopping For?
  4. Where Should I Go for Bad Credit Car Financing?
  5. Where Should You Be Careful About Financing a Car With Bad Credit?
  6. How Do I Apply For an Auto Loan With Bad Credit?
  7. What Should I Do if I am Declined?
  8. How Do I Decide on the Right Deal?
  9. What If I Can’t Make My Car Payment?

What Is Bad Credit?

When you apply for an auto loan, your credit score is one of several critical factors that lenders consider. A credit score is a three-digit number ranging from 300 to 850 points, and it’s based on the information in your credit reports. It takes into account your history of paying your bills and loans on time, the amount of credit you have, how much credit you are using, and the number of inquiries for new credit you are requesting.

Your credit reports are generated by three major credit reporting agencies: Equifax, Experian, and TransUnion.

There are many credit scoring models available, and different lenders use different models. One of the more common is the FICO scoring model. It takes the range of credit scores (300 to 850 points) and breaks it down into smaller categories. FICO defines very poor credit as a score between 300 and 579, according to Experian, while a score from 580 to 669 is considered fair credit. Both the very poor and fair ranges fall into a category called "subprime." Some lenders refer to the lower tier as "deep subprime."

Loan companies consider applicants with scores in the 670 to 739 range to be good credit risks. Those with a score higher than 740 are regarded as excellent credit risks. They are typically offered the best car loan terms and are eligible to get special lease incentives and financing deals from automakers.

There are other factors besides your credit score that affect your creditworthiness. Lenders also consider your employment history, your capacity to repay the auto loan based on your monthly income, and the value of the collateral you are putting up for the car loan. The vehicle is usually the secured collateral with an auto loan, and the lender has the right to take it back or “repossess” it if you don’t make your payments.

How Do I Know How Bad My Credit Is?

You can do more than just watch your mailbox for late notices to know if you have poor credit. It’s a good idea to explore each of your credit reports to understand what’s really happening.

Fortunately, knowing your credit standing has never been easier. A benefit of many credit cards is the ability to see your score using their online portals. You can also pay the credit reporting companies to see your score (though you can get your report for free).

Once you see your credit score, you can delve into your credit reports to understand why you have that score.

Federal law allows you to see your reports from each of the three major credit bureaus once each year for free. You can also get a report from any credit bureau that provided the information to a lender that declined your application. AnnualCreditReport.com is the only site that is authorized by federal law to provide your free annual credit reports. You’ll see many lookalike sites on the internet that offer to do the same, but most of them will eventually ask for money, ask for critical information that can lead to identity theft, or automatically sign you up for difficult-to-cancel, unnecessary, and expensive credit monitoring services.

Look closely at your reports for errors. They do occur, and they can take some time to clear up. That’s a good reason to start examining your credit well before you start your car shopping.

Catching up on your account and making timely payments are two of the quickest ways to get bad credit back on track. You may have to make sacrifices elsewhere else in your budget, but the effects on your credit score can be significant within a few months.

“They are more empowered to know their credit score and what is in their credit file,” says Brian Landau, senior vice president and automotive business leader at TransUnion, about today’s car buyers. “They know that if they wait they can get a better rate.”

It is important not to panic and start closing credit cards. Your credit score reflects both the amount of credit that companies have extended to you and the amount of that credit that you are using. Closing  accounts reduces your available credit, and it raises what is called your credit utilization rate, or the ratio of credit card balances to credit limits. Think of it as a percentage that tells lenders how much of your credit you are using.  

For example, if you have credit card balances of $5,000 and the limits on all of your cards total $20,000, your credit utilization rate is 25 percent. If you were to close a card with a $5,000 limit, your credit utilization rate would leap to 33 percent and have a negative impact on your credit score.

Odds are you won't have time to create tremendous advances in your credit score before you want to buy a vehicle, so next, let’s look at how to get an auto loan while you are is still considered a high risk by lenders.

What Kind of Car Should I Be Shopping For?

When you have bad credit, it’s important to find a vehicle that doesn’t get you into deeper financial trouble. While you can probably find a dealer that can get you financing for a loaded sports car or SUV, that might not be the best choice for your financial future.

Getting a car loan while you have poor credit gives you two opportunities: You can get an affordable vehicle and you can improve your credit standing by using the auto loan to prove to the credit bureaus that you are a good credit risk. Buying a more expensive vehicle than you can afford can make these goals less attainable.

Instead, you want to look past just the monthly payment and consider the total cost of the loan and the total cost of owning the vehicle, including car insurance, maintenance, and fuel. Knowing the cost of these components can help you determine your budget.

Instead of looking at the latest and greatest vehicles, you might need to consider a used vehicle instead. By opting for a well-kept factory certified pre-owned car (CPO car) rather than a brand-new model, you can save a tremendous amount of money. You’ll also get a warranty to reduce your exposure to unexpected repair costs, along with several other benefits, such as roadside assistance.  You can learn more about used car financing in How to Finance a Used Car.

Even if you feel the need to buy a new car, you might want to temper your expectations. While you may like the idea of a 2018 Hyundai Sonata, the much less expensive 2018 Hyundai Elantra may meet your needs.

All of that is not to say that you need to buy the cheapest vehicle you can find. You'll want to carefully evaluate each contender's predicted reliability, efficiency, and cost to insure. If you’re putting thousands of dollars into repairs each year, filling up the gas tank all the time, and paying exorbitant amounts for car insurance, you won’t have the cash to make your loan payments.

Our new car rankings and reviews and used car rankings and reviews can help guide you to the perfect automobile. You can compare cars based on their efficiency, safety, and a host of other factors. Our research is based on the consensus opinion of the country’s top automotive journalist combined with quantitative data such as predicted reliability ratings. Any personal biases from our staff do not enter into our rankings research. To maintain our objectivity, we don’t accept expensive gifts or trips from the automakers.

Where Should I Go for Bad Credit Car Financing?

Many consumers put off figuring out their auto loan until the end of the buying process when they're sitting in the dealership's financing office. It’s a convenient way to get financing, but as a customer with bad credit, you simply cannot afford to do that. Before you get near a car dealership, you want to have a preapproved auto loan offer in hand.

If the dealer is able to beat the offer, that’s great, but if they don’t have any competition for your business, they have no incentive to find you a good deal. Many dealerships make a substantial part of their income from financing, and in many cases, the offer they make to you will be one that is good for their bottom line, not for yours.

Of course, most dealers are honest and open, but some are not. Having a deal in hand is the best way to ensure that they are working to get you a better deal and not pad their profit. It’s uncommon for a franchised new car dealer to fund your auto loan themselves. Instead, they your send application to a number of lenders and then offer you one of the deals that is approved. However, there’s a catch – the lender may tell the dealer that they will fund the car loan at 4 percent, for example, but the dealer is not obligated to tell you that. Instead, they may say to you that the best deal they could find is 6 percent. That extra 2 percent becomes profit for the dealership. Compensating the lender a little for the convenience of a one-stop shopping experience is reasonable, but paying an excessive markup doesn't provide you with anything to show for the extra money you’d spend.

“A lot of consumers don’t know about that, and the dealer does not need to be transparent about that,” says Joe Pendergast, Navy Federal Credit Union’s vice president of consumer lending.

Fortunately, you have plenty of options when it comes to finding an auto loan that don’t require using a car dealer as a middleman.

Large national banks offer loads of services, resources, and great online tools to help you get financing. If you have bad credit, however, you might want to find an institution with a bit more of a personal touch. You can find that with a smaller, local bank or credit union, where you are more likely to be able to talk to a person who will listen to your circumstances and take them into account when making a decision.

Credit unions are member-owned cooperatives that often can extend better loan terms than most banks because their profits are returned to members in the form of lower rates, rather than as dividends to shareholders. They range from tiny, one-person operations to institutions that are larger than many of the country’s banks.

Online-only banks can offer lower loan rates than many brick-and-mortar banks because they don’t have expensive branches to support. You may not find the hand-holding that you would experience with smaller institutions, but the banking and loan deals they offer can sometimes make up for the impersonal experience.

Many financial institutions offer special programs for customers with poor credit and those who have never purchased a vehicle before. These programs may require larger down payments, offer shorter loan lengths, and have higher interest rates than those available to other borrowers, but they provide a path for car ownership that you otherwise would not have.  

Where Should You Be Careful About Financing a Car With Bad Credit?

If you see a lender with advertisements that proudly proclaim that they can loan money to anyone, you should consider that a red flag. While some of those lenders may have your best interest at heart, many prey on uninformed or desperate consumers who just need a car. If a lender sees you as a risky borrower and offers to loan you a lot of money for a long term, that risk will be priced into an expensive loan.

Another type of dealer that can be seen as the last resort for borrowers with poor credit is the “buy here pay here” used car dealer. At this type of dealer, you purchase the car and make regular payments to the dealership. In general, these types of dealers make much more on the financing than they make on the car. Since there is a lot of risk involved in making these loans, buy here pay here dealers are very aggressive about ensuring you make your payments. They often install a tracking device in the vehicle so they can quickly repossess or even disable the automobile if they do not receive their payments on time.

It’s not uncommon to see interest rates ranging from 18 to 30 percent at buy here pay here dealers. With such high rates, it can be hard for borrowers to get out of debt. If you miss even one payment at many buy here pay here dealers, you risk having your car repossessed, which can cause a lot of damage to your credit report.  

How Do I Apply for an Auto Loan With Bad Credit?

There’s not a lot of difference between the loan application process, whether you have excellent credit or you’re applying for a bad credit auto loan. You’ll fill out a credit application that asks you for information about your debts, income, job, and monthly expenses. It may ask you about your marital status, sex, where you live, and other personal information. Lenders are limited on what information they can consider when making lending decisions, but they may ask for it anyway.  

If you are a subprime borrower, the lender may ask for more documentation about your income, employment, debts, and other assets than they may request from a prime or super-prime borrower. If you work in a trade that requires a license, they may ask questions about whether your license is current and if you are legally allowed to work in your chosen field.

From the information they gather, they’ll develop a debt-to-income ratio that measures your capacity to repay the auto loan.

It is critical that you be completely open and honest in the application process. If you didn't tell the truth about something or omitted information on your application, it can lead to the lender declining your application. If it is discovered at a later time in the loan term, the lender can immediately declare that the entire balance of the loan is due immediately, or change the terms of the financing.

You’ll need to apply to several lenders, so you get several offers to choose from. You will want to do so in a relatively short period of time, though, as request for new credit will drop your credit score a few points. The credit reporting agencies will see many inquiries for the same type of loan occurring in a short time frame as just one inquiry, so the damage to your credit score will be minimal.  

What To Do if You Are Declined for a Car Loan

If you are declined when you apply for a loan, it means that the lender has reason to believe that you will not pay the money back. Instead of taking it as an insult, you should consider the fact that a professional is trying to keep you out of deeper financial trouble.

The lender is required to tell you the reason why you were declined. If it was because of an item on your credit report, the credit reporting agency must provide you with a copy of your credit report.

What you don’t want to do is wait a few weeks and apply for credit again. You risk having your new application show on your credit report as another inquiry, which lowers your score even more. Either make applications in quick succession or put several months between each application.

A few other things you don’t want to do if you can’t get a loan: Don’t be tempted to use a credit card to pay for a car, as they usually come with very high interest rates. Don’t take out a personal loan that uses your home as collateral, or you may risk losing both your home and car. Getting a co-signer may allow you to secure a loan, but it puts the credit ratings of both you and your co-signer at risk and can destroy relationships.

With time, you can also gather more money to make a larger down payment, which makes bad credit car loans more attractive to lenders.

How to Decide on the Right Deal

As a borrower with a credit history that has some dings, you should not expect a low-interest loan or generous credit terms. Responsible lenders will offer you auto loans that need to be paid back in a relatively short time, have higher interest rates, and smaller loan amounts than they would offer to borrowers with top-notch credit. They may require you to pay a substantial amount of money down and not allow you to roll any previous car loan balance into your new financing.  

If you are offered seven- or eight-year loan terms, or you are encouraged to roll the remaining balance of your current auto loan into the new financing, you’re probably not working with a lender that has your best interest at heart. Such loans can bury you in debt and leave you with a significant amount of money to pay back even if you wreck the car or it is totaled. Any time the balance of the loan is higher than the cash value of the vehicle, you are considered to be upside-down or underwater on the loan. By rolling the balance of another loan – also called negative equity – into your new auto financing, you'll be upside from day one.

After you have multiple offers, you’ll want to compare the total cost of each, not just the monthly payment. The math is pretty simple, though you’ll have to use a car loan calculator to figure out your expected monthly payment amount. Take that number and multiply it by the number of months in the loan term. Then add that number to the amount you’re paying up front, plus the value of your trade-in, and you’ll have the total cost of the vehicle.

We’ll use the purchase of a 2018 Hyundai Sonata to illustrate. The base model has a price tag of $22,050, and let’s say you finance it for five years at 8 percent, make a down payment of $2,000, and trade in a vehicle worth $3,000. With the down payment and trade-in, you’ll only be borrowing $17,050 of the purchase price. Using a financial calculator, you’ll find that the monthly payment is $346.

Next, multiply the $346 by the number of months in the loan term (60) then add the down payment ($2,000) and the value of your trade-in ($3,000). Do the calculation and you'll see that the total cost is $25,760.

By doing this math for every offer you get, you can compare proposals with different interest rates, loan terms, and payment amounts. In many cases, you’ll find that a lower monthly payment does not lead to a lower overall loan cost, especially if the route to that lower payment has you adding months or years to the auto loan.

Be sure to think about any taxes and fees that you have to pay up front. Failing to do so can lead to a nasty surprise when you get to the dealership’s financing office.

If you wait until you visit the dealer to seek financing, they will likely want to bundle the price of the vehicle, the terms of the financing, and the value of your trade-in into one transaction. You, on the other hand, want to treat them each as different transactions, so that you can avoid confusion and see the real cost of the vehicle. Coming in with your own financing deal can unbundle that component of the transaction from the negotiation.

Signing the Paperwork

You’re getting close to the point where you can drive your new or new-to-you car home. However, it's essential that you take the time to read any documents before signing them. You want to ensure that they are accurate and complete, and they reflect the deal that you agreed to. Be sure that you get a copy of any document you sign so that you have proof of what was agreed to.

If you see any issues with the paperwork or any areas that are not filled out, do not sign the documents. Even if the finance officer promises they'll fix the problems later, you should not sign the papers unless it is taken care of at that time. Once they have your signature, it becomes much harder to prove that you did not intend to agree to the terms.

Sometimes dealers will send you home in your new ride thinking that you have everything complete. Then several days later, you'll get a call from the dealer saying that the financing deal that they tried to get for you didn't pan out and you have to come back to sign new paperwork. When you return to the dealership, the new deal is significantly more expensive than the old agreement, with a higher interest rate, a longer term, or both.

It's called yo-yo financing or spot delivery. In some cases, it's true that they couldn't get your financing approved, while in others it’s a ploy to get you to fall in love with the car before telling you that it will cost much more than you thought. Some states have laws that protect consumers from abuses from spot financing, while others have laws favoring dealers.

Customers with a bad credit history are especially vulnerable to spot financing abuses, as they often feel that they have no choice to accept whatever new terms the dealership is offering. Though there might be extreme pressure to sign the new loan contract, your best path is to return the car and go elsewhere for a different deal. It’s another case where having financing preapproved before you go to the dealership can keep you out of trouble.

What Else Do I Need to Do?

If you are purchasing your car from a dealer’s inventory, they will usually take care of all of the registration and title paperwork (and charge you a fee for doing so). When buying from a private party, you’ll have to take care of the paperwork yourself and likely take a trip to your local DMV to get all of the registration documents properly filed.  

Most auto lenders require borrowers to have collision and comprehensive car insurance on any car that they finance. This protects their collateral, the car, in case it is stolen or totaled. This is different than the liability insurance that you’re required to carry in most states, which protects others against the costs of injury or damage from your vehicle.

With bad credit, you can expect to pay significantly more for car insurance. Auto insurance companies can show links between low credit scores and high insurance payments, so they can legally discriminate against consumers with poor credit by charging them higher prices.

It’s a great idea to set up an automatic payment plan that deducts your monthly payment from your bank account on a recurring basis. That way, you’ll never be late for a loan payment. Some lenders offer discounted rates if you agree to automatic payments.

No matter where you get your financing, the lender will hold the title to the vehicle until you make your final payment. In some states, you’ll have to contact or visit a DMV office to complete the title transfer.

Refinancing Your Car Loan

After you have had your auto loan for nine months to a year and have made timely payments, it’s an excellent time to think about refinancing. Not only will your credit score likely have improved, but you’ll also have a better loan-to-value ratio, a lower auto loan balance, and a pattern of timely payments. There’s nothing that the credit reporting industry values more than payments that are made on time.

According to a recent study by TransUnion, borrowers dropped their interest rate by 2.4 percent when they refinanced their auto loan.  

You’ll want to approach refinancing just like you approached your initial auto loan. Seek out offers from several lenders, evaluate them, and then apply for the new loan. Some lenders have special refinancing programs with streamlined procedures for completing the application process. Be careful about using refinancing to extend the length of your contract. You don’t want to be in the position of still having car payments at a time in your car’s life that it needs costly repairs.  You can learn more in How to Refinance a Car Loan.

What if I Can’t Make My Car Payment?

Getting an auto loan with bad credit can be an excellent stepping stone on your journey to a higher credit score. It can also be devastating to your credit standing if you are unable to make timely payments or default on the loan. Your car can also be repossessed, and in many states, you are responsible for any loan balance that is not satisfied after the lender sells your car.

What can you do if you can't make your payments? There are a few things, and it is best to be proactive in pursuing them before you are so deep in a hole that you can't climb out. Reaching out to your lender and discussing your circumstances is a good start, as most lenders are reasonable and will be as determined to help you avoid a default as you are.

If the conditions that puts in you in jeopardy are short term, such as a family emergency that took a month or two of car payments, your lender may work with you to defer the obligation until things stabilize. Your interest will still accrue, but you won’t have to make monthly payments. You may also be able to arrange for partial payments that will at least cover the car loan’s interest.

For borrowers with longer-term cash-flow problems, lenders can work to refinance or restructure loans to find terms that you may be able to work with. That might include extending your auto loan term or lowering your interest rate based on your previous payment history.

When things are looking really bad, and you don't see a way to make your payments, it is best to quickly sell the car and pay off the loan before you go into default. You’ll want to find the path to selling that gives you the best cash value out of the car, and that’s usually by selling it yourself. When you sell the vehicle yourself and use that money to pay off the auto loan, you protect the advances in your credit rating you have made and avoid the massive hit to your score that a default and repossession would cause.

Even if you are on the path to repossession, you can save yourself a bit of money. By voluntarily allowing your lender to take the car, you can save the costs of the repossession process, which are frequently added to your auto loan balance and you are responsible to pay.

More Shopping Tools From U.S. News & World Report

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