Need new wheels but can’t afford to pay cash?
You’re not alone. Federal Highway Administration statistics show that in 2016 there were more than 264 million private and commercial vehicles registered in the U.S. According to a 2018 first-quarter analysis by Experian, the majority of vehicle purchases were financed.
Cars are an essential purchase for many Americans, and they don’t come cheap. According to a Q1 2018 analysis by Experian, the average auto loan for a new car was $31,455, while for used cars it was $19,536. People with credit scores in the “prime” and “super prime” ranges accounted for the majority of loans and leases for both new and used vehicles in the first quarter of 2018, Experian reported.
Not everyone can borrow a five-figure sum to get a car, and if you have a poor credit history, doing so can be even more of a challenge. Still, car loans for people with bad credit can be found. But being a risky borrower in the eyes of a lender means there’s a good chance you’ll pay a higher interest rate.
Here are some things to know about auto financing options when you have bad credit.
Prep for borrowing success
You might not have time to take steps to improve your credit before you need to apply for a car loan. But if you can plan ahead, you can take steps to prepare for a better borrowing experience.
Work on your credit
One of the first things you should do before shopping for an auto loan is to understand your credit. Check your credit reports to see if there are any negative items listed, such as delinquent accounts, that are inaccurate and dispute any incorrect information. You can check your Equifax® and TransUnion® credit reports for free on Credit Karma. It’s also a good idea to check your credit scores to get a look at what your lender might see when reviewing your loan application.
How to dispute an error on your credit report
Other steps that can help improve your credit health include …
- Paying all your bills in full and on time every month
- Paying down existing debt
- Avoiding applying for multiple new credit in a short period of time, if possible
Remember, people with good credit typically qualify for lower interest rates, which can make a big difference in monthly payments. In fact, Experian’s Q1 2018 analysis found that people with credit scores in the “super prime” range paid $43 less per month on average for an auto loan than those whose credit scores were in the “nonprime” range.
Save for a down payment
Mike Kane, vice president of consumer credit operations at Ally Financial, says it’s also a good idea to “save money for a more-significant down payment, make sure you are paying your bills on time, and reduce your outstanding debt as much as possible.”
Having a bigger down payment will reduce the amount of the loan you need, Kane says.
You can also shop for car loans online and apply for preapproval.
The preapproval process may involve the lender checking your credit reports, credit scores, current income and other expenses to see what loan amount and interest rate you could qualify for. Before applying for preapproval, consider checking auto loan rates with an online lender, your bank or, if you’re a member, your local credit union.
“If you have a relationship with a bank, start your shopping with them first, because the more of a relationship you have, the more you can leverage on that,” recommends Ogechi Igbokwe, founder of One Savvy Dollar.
To minimize the impact that shopping for an auto loan can have on your credit, it’s a good idea to shop for rates within the same time period. FICO® scoring models count multiple credit inquiries of the same type within a 45-day period as a single inquiry. VantageScore counts multiple inquiries, even for different types of loans, within a 14-day period as a single inquiry. These time frames are something you should keep in mind when shopping around.
Compare interest rates and loan terms to understand how much money you’ll actually have to pay back over the life of the loan.
For example, a car loan with a 60-month term and a 4.89% APR will cost you considerably less than a loan with the same term but a higher 8.14% APR.
If you have bad credit and can’t get preapproved for an auto loan from a financial institution, you might be able to get a loan from the car dealership. But be aware that the interest rates on these loans can be higher than what you’d get from a lending institution. If you have bad credit, you’re more likely to get a higher interest rate, because you may be viewed as a risky borrower — another reason it’s important to shop around before you head to the dealership.
Should you use a personal loan to buy a car?
Many financial experts would say a personal loan should be one of the last financing options you consider for purchasing a car. It might be tough to get approved for the larger amounts needed for a vehicle, and personal loans can have higher interest rates.
Because personal loans are unsecured — meaning they don’t require collateral — it can make getting approved more difficult.
“Auto loans can have lower interest rates and are tailored specifically for the purchase of a car or truck, which tends to make the [borrowing] process easier,” Kane says.
But unlike personal loans, auto loans often require a down payment.
The vehicle you’re buying can often serve as collateral for the loan.
How can I get a better rate?
Even if you end up with a car loan with a high interest rate, it doesn’t have to be permanent.
If you can improve your credit by making consistent on-time and in-full payments, and by using only a portion of your available credit, consider refinancing your loan to get a better interest rate.
“Car loans generally offer lower interest rates than personal loans, so if your goal is to refinance your way to a lower rate, an auto loan is usually the better option,” Kane says.
When should I refinance my auto loan?
If you’re thinking about refinancing do the same due diligence you did when you first purchased the car. Shop around for rates and terms with different lenders, online and bricks-and-mortar banks, and with your local credit union. Plus you can check with your original lender to see if you can refinance at a lower rate.
When you decide on a lender to refinance with, the lender will likely run your credit again and look at your income to determine your creditworthiness, so if your credit or financial situation has improved — say, you got a raise at work or have switched jobs and now earn more — it could position you for a loan with a better rate and better terms.
Getting a car loan with bad credit can be a challenge. And even if you’re approved, the higher interest rate you’ll likely get can make it more expensive for you to borrow money.
But taking steps to improve your credit before you go car shopping can lessen some of the financial blow. And consider saving as much cash as you can for a down payment, or going with a more affordable, yet reliable, car that meets your needs but requires you to borrow less.
When you’re already working hard to repair your finances, taking on the least possible amount of debt can help ensure you can afford to repay your debt and keep your credit on track.