Introduction
Buying a car is an exciting experience, but getting approved for an auto loan can be challenging if you have bad credit. A low credit score indicates to lenders that you may be a high-risk borrower. However, there are still financing options available if you have poor or no credit. This comprehensive guide will walk you through everything you need to know about getting a car loan with bad credit.
Understanding Credit Scores
Your credit score is a three-digit number that gives lenders an idea of how reliably you pay back debt. Scores range from 300 to 850, with higher scores indicating better creditworthiness. Here is a breakdown of the credit score ranges:
- 800-850: Exceptional
- 740-799: Very Good
- 670-739: Good
- 580-669: Fair
- 300-579: Very Poor
Most lenders consider scores under 580 to be bad credit. The lower your score, the harder it will be to get approved for financing. Your score also determines the interest rate and terms you are offered. Focus on improving your credit before applying for an auto loan to increase your chances of getting approved and securing better rates.
Why Lenders View Bad Credit as Risky
Lenders associate bad credit with higher delinquency rates. Borrowers with low scores are considered more likely to:
- Make late payments
- Default on loans
- Go bankrupt
From a lender's perspective, the risk of not being paid back goes up significantly when working with subprime borrowers. That is why bad credit translates to higher interest rates, larger down payments, shorter loan terms, and increased chances of getting denied.
Improving Your Credit Score
The best way to get affordable auto financing is to spend time improving your credit first. Here are some tips to raise your score quickly:
- Pay all bills on time - Payment history is the biggest factor in your score. Set up autopay and calendar reminders to avoid missed payments.
- Pay down balances - High utilization rates on credit cards hurt your score. Pay off cards with 30% or higher balances.
- Dispute errors - Errors on your credit reports drag down your score. Initiate disputes to remove inaccurate information.
- Limit hard inquiries - Too many applications for credit make you seem desperate. Only apply for credit you need.
- Become an authorized user - Being added as an authorized user on someone's old account boosts your score.
- Monitor your credit - Sign up for free monitoring services to catch issues early.
It can take several months of diligent credit repair to significantly boost your score. But the wait is worthwhile, since a higher score can save you thousands on your auto loan.
Getting Pre-Approved for Bad Credit Auto Loans
Pre-approval entails submitting a credit application to lenders to see potential loan offers before you start shopping. It indicates you are a serious buyer so dealers take you more seriously. Pre-approval also gives you a realistic idea of the loan amount, interest rate, and terms you qualify for based on your credit score and income.
Here are some tips for getting pre-approved with poor credit:
- Apply with subprime lenders that specialize in bad credit loans, such as Capital One, Credit Acceptance, and Westlake Financial. Avoid mainstream banks that likely will deny you.
- Shop around with multiple subprime lenders to compare interest rates and loan terms. Each lender evaluates applicants differently.
- Provide accurate information on your application and be prepared to verify details with documents if requested. Any exaggerations could be considered fraud.
- Ask lenders if you can get pre-qualified first, which is a soft credit check that won't hurt your score. Pre-approval involves a hard inquiry that can slightly ding your credit temporarily.
- Accept the loan with the most favorable terms that you comfortably can afford. Avoid loans with extremely high interest rates or unreasonable repayment requirements.
The Pre-Approval Letter
When you are pre-approved, the lender will issue you a pre-approval letter to show dealers. This letter should specify the following:
- Name of borrower(s)
- Pre-approved loan amount
- Interest rate
- Down payment required
- Monthly payment
- Date the pre-approval expires
The letter indicates you have financing lined up and are ready to move forward with a purchase. Be sure to only shop for vehicles priced within your pre-approved loan amount.
Choosing the Right Dealership
Not all car dealerships will be willing to work with bad credit customers. Franchised dealers that sell new cars are often reluctant to take on subprime borrowers perceived as high risk. Instead, focus your search on:
- Buy Here Pay Here (BHPH) dealers: BHPH lots arrange financing in-house for credit-challenged buyers. They offer simple approvals but charge higher prices and rates.
- Independent used car lots: Independent dealers are more likely than franchises to accept bad credit. They have relationships with subprime lenders to arrange financing.
- Subprime auto financing companies: Some subprime lenders operate dealer networks specifically catering to buyers with poor credit. These include America's Car-Mart, DriveTime, and OneMain Financial.
When contacting dealers, let them know upfront you have pre-approval through a subprime lender. Share your letter to give the dealer insight into the terms and amount you qualify for.
Bad Credit Auto Loan Approval Process
The loan approval process at a dealership includes these steps:
1. Review your credit history - The dealer will pull your credit report to review your score, income, debts, and payment history.
2. Verify your down payment - Make sure to bring your down payment with you. The amount required depends on your credit score and the vehicle cost.
3. Complete loan application - Provide accurate details on the loan application to avoid issues verifying your identity and income later.
4. Submit for financing - After you pick out a car, the dealer sends your application to their financing providers. If you have pre-approval, they try to match or beat the terms.
5. Accept final loan terms - Carefully review the final loan agreement before signing. Make sure you understand the interest rate, length, and monthly payment amount.
Down payments for bad credit auto loans generally range from 15% to 30% of the vehicle's selling price. The lower your credit score, the larger down payment required. Come prepared with the full down payment amount so you can purchase your car the same day if approved.
Receiving prompt loan approval depends on the accuracy and completeness of your application. Have all of your necessary documentation ready, including:
- Government-issued ID
- Proof of income - Recent pay stubs or bank statements
- Residence information - Utility bills or rental agreement showing your address
- Down payment funds - Cash, money order, certified check
- Insurance binder - Proof you have an insurance policy for the new vehicle
Being organized and thorough upfront prevents delays finalizing loan terms and taking delivery of your new car.
Acceptable Vehicles for Bad Credit Loans
Since bad credit loans carry more risk for lenders, they impose more restrictions on eligible vehicles. Avoid luxury, performance, and specialty cars. Lenders prefer common, affordable, fuel-efficient sedans and small SUVs. Here are top vehicles for buyers with low credit scores:
- Nissan Versa - Reliable subcompact with excellent safety scores and affordable pricing. Easy to insure.
- Toyota Corolla - Legendary compact sedan or hatchback offering great value retention and gas mileage.
- Honda Civic - Fun-to-drive compact car with nice interior space and solid reputation for dependability.
- Subaru Legacy - Safe midsize sedan with standard AWD capability and good predictive reliability ratings.
- Ford Escape - Capable compact SUV with abundant cargo room. Maintains value well.
- Hyundai Tucson - Stylish small SUV with a 10-year/100k mile powertrain warranty for added peace of mind.
Stick to 2-5 year old used models in the mileage range of 40k-80k miles. Higher mileage vehicles likely need more maintenance and repairs that add to your costs.
What Interest Rates to Expect with Bad Credit
Credit scores under 620 will mean paying double-digit interest rates between 15-30% APR for your auto loan. The better your credit score within the bad range, the lower the rate lenders will offer. Here are the average rates by score:
- Credit score 500-539 - 22% APR
- Credit score 540-599 - 18% APR
- Credit score 600-619 - 15% APR
Rates also depend on factors like your debt-to-income ratio, down payment, and the auto loan term length. A shorter 3 year term will mean a higher payment but saves thousands in interest versus a 6 year loan.
Always negotiate the interest rate offered rather than accepting the first option. Even shaving off 1-3 percentage points will significantly lower your payment and long-term costs.
Risks of Bad Credit Auto Loans
Higher interest subprime loans enable auto financing for borrowers with poor credit at the expense of taking on additional risks:
- Potentially unaffordable payments - Higher monthly payments make it harder to keep up and increase risk of default.
- Possibility of repossession - Your car can get repossessed if you miss multiple payments and fall far behind.
- Loan terms are less flexible - Refinancing to lower rates or trade in for a different car is harder with bad credit.
- Loan lasts longer than car - You may still owe payments after the car is paid off or requires expensive repairs.
- Significant interest charges - Interest expenses consume more of your payment over the life of the loan.
While undesirable, these risks are manageable if you are careful and responsible about the auto loan process. Do your homework upfront and practice sound financial habits going forward to avoid issues.
Tips for First Time Car Buyers with Bad Credit
If this is your first time purchasing a car, employ these tips to make the financing process smoother:
- Get educated on the car buying and loan process so you know what to expect. Watch out for deceptive sales tactics.
- Shop around for the best loan instead of taking whatever the dealer offers. Compare multiple pre-approval offers.
- Read all paperwork thoroughly before signing and make sure you clearly understand the terms. Don't hesitate to ask questions.
- Bring someone with you who is experienced with auto purchases. They can provide a second opinion.
- Limit additional extras like extended warranties that raise the price. Stick to necessities only.
- Practice budgeting for your monthly payment well in advance so it fits comfortably in your expenses.
- Meet all loan requirements like maintaining insurance and registering the vehicle properly. Lapsing can lead to repossession.
- Build up your credit history with responsible borrowing behavior. Refinance at a lower rate when your score improves.
Following these best practices will lead to a positive financing experience and put you in better shape for your next auto purchase.
Using Bad Credit Auto Loans to Rebuild Credit
The silver lining of bad credit car loans is they provide a means to improve your credit if managed prudently:
- Make payments on time - Stay disciplined about paying at least the minimum due monthly and on or before the due date. Setting up autopay can help. Payment history is the most influential credit scoring factor, so diligent on-time payments will quickly boost your score as you demonstrate responsible behavior.
- Keep loan balance low - Pay down principal aggressively so you owe less. High balances tend to lower credit scores.
- Limit hard inquiries - Only apply for credit you need to avoid too many inquiries that denote high risk. Wait at least a year before applying for new credit.
- Maintain length of credit - Keep the loan open until repayment is complete. Long, established accounts improve your score.
- Monitor your credit - Review your credit reports regularly to check for progress and catch any reporting errors early.
Sticking to these credit habits will cause your auto loan to improve rather than hurt your credit standing over time. Just be cautious about relying too much on borrowing to rebuild credit. Using a mix of responsible credit, solid payment history, and low debts is the optimal path to credit recovery.
Conclusion
Bad credit makes getting approved for an auto loan more challenging but definitely possible with the right preparation and knowledge. The key is taking time upfront to improve your credit, research lenders, get pre-approved, and compare options instead of just accepting a dealer's first offer. Be realistic about what you can afford and stick to vehicles that match your budget and loan terms. With patience and diligence, a bad credit car loan can put you in a reliable vehicle and also provide a gateway to rebuilding your credit for the future. Just stay focused and committed to making payments on time once approved.
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