The amount of credit-challenged American consumers has been steadily growing in the post-recession era. In fact, experts now report that 1 out of every 4 adults has a credit score that is below 620, typically regarded as the cut-off line between “fair” and “bad” credit. As you know, credit problems make it more difficult to obtain any line of credit, especially a large installment loan for a new or used vehicle. That is because auto lenders are most concerns with two aspects of every consumer application they review: credit score and income.
Credit Score: The Foundation of Financing
A credit score gives lenders a good indication of how likely any individual is to repay their loan. Banks and lenders are, after all, in the business of managing risk. If a candidate has a poor record of paying off their debts, especially as it relates to car loans and leases, then lenders will either a) deny the person a loan, or b) approve the person under conditions that minimize risk, such as a higher rate of interest (APR), higher down payment, lower loan-to-value ratio (LTV), and other means. Unfortunately, this can make the loan more expensive for you, the borrower, so it is doubly important to shop for the best rate and lending terms.
Getting a Car Loan with Bad Credit
The vast majority of banks will not fund loans for people with bad credit. Credit unions are more lenient, but they too tend to turn away consumers with credit scores below a certain point. That said, approximately 25% of vehicle loans each year are for people with subprime credit. The majority of these “bad credit” car loans are funded by auto finance companies that specialize in the subprime market. Most of these loans are actually arranged through the dealership, as dealer “F&I” (Finance & Insurance) agents have relationships with such lenders. Those that cater to this clientele are often known as “bad credit car dealerships.” Unfortunately, this can lead to a long, stressful process in the dealer F&I office, as a harried agent works to secure you funding. Who wants to spend hours at the dealership, sweating over funding?
The better path to approval is to arrange your financing ahead of time. This is where we come in. When you apply online through us, we match you to a dealer or lender who is willing to finance you, despite your credit problems. You can then work directly with your finance professional to work out the details of your lending agreement. Lastly you will head to the dealership to select your car, enjoying the confidence of pre-approved financing.
Auto Finance Rates for People with Bad Credit
Interest rates vary widely, even for people with bad credit, based on a complex matrix of factors, which include: exact credit score, length of loan, down payment, amount financed, vehicle type, location, and more. For this reason, it is impossible to predict your auto loan APR with any degree of precision. However, we can offer some very general approximations as to bad credit car loan rates on a national level, based on credit score.
|FICO||48-Month Used Car Loan APR||48-Month New Car Loan APR|
|660-689||10-11% APR||7-9% APR|
|620-659||14-16% APR||10-12% APR|
|590-619||18-19% APR||15-17% APR|
|500-589||19%+ APR||17%+ APR|
As you can see, used vehicles are plainly more expensive to finance than new ones, simply because they have a higher risk of breaking down. However, this elevated rate of interest may be offset by their reduced price and susceptibility to depreciation.
Minimizing Your Auto Loan APR
There are strategies you can use to secure the lowest rate possible.
- Check for and dispute credit report errors. Did you know that mistakes and inaccuracies on consumer credit reports are quite common? Pull your yearly report for free from annualcreditreport.com. If you see any errors, file a dispute with the reporting agency in question. If you are able to have a negative item removed, your score could be significantly boosted in short order.
- Ask the “Buy Rate” offered by your lender. The “buy rate” is the annual percentage rate given to the dealer by the lender. Unfortunately, this is often higher than the “contract rate,” the rate the dealer tries to give you. This makes the dealer extra profit, which comes straight out of your own pocket. You want to negotiate your rate to be as close to the buy rate as possible.
- Finance for the shortest term possible. The shorter your repayment term, the lower your rate. The average auto loan is now nearly 65 months, but you are better off staying below 60 months if possible.
Bad Credit, Negative Equity, and Down Payments
Negative equity is the state of owing more on an asset than it’s worth–otherwise known as being “upside down.” With car loans, it’s a a huge risk, because cars depreciate so quickly. If get a loan of $15,000 for a $15,000 car, and it is worth only $12,000 the month after you buy (not uncommon), then you are suddenly in the whole by around $3000! Couple this with the interest rates associated with subprime financing, and you have a recipe for serious negative equity. For this reason, it is important to offer a down payment. That way, you won’t have to finance 100% of the vehicle’s purchase price, and the amount you owe vs the value of your vehicle will stay more in line. Typically, a down payment of 20% is optimal. If you don’t have that kind of cash to put down, keep in mind that an existing vehicle can typically be trade in for a cash allowance that can be put toward your down payment.
How Much to Spend
There are two primary guidelines for determining how much to spend.
- Monthly Payment. It is best to allocate no more than 10% of your monthly pre-tax income toward your monthly car payment. Staying closer to 5% is actually ideal.
- Loan Length. Since the above guideline keeps your payment low, it may be tempting to lengthen your repayment terms so that you can afford a more expensive car. However, it is generally best to opt for the shortest repayment term possible. This keeps your total interest low and reduces negative equity. Opting for a car loan shorter than 60 months is ideal.
If you adhere to these two guidelines, you should be able to secure a loan that works well with your budget.
Rebuilding Your Credit through Financing
It is true a car loan can help you rebuild your credit, under one very important condition: you make all of your payments on time. That’s why budgeting properly, according to the guidelines above, is so important. You want a monthly payment that won’t strain your finances, so that there is no risk of missing payments. Paying off your loan as agreed for 6-12 months can boost your score nicely, and some experts state that a 5-10% increase in score on a monthly basis is not out of the question.