Having bad credit and trying to get an auto loan can be like turning the key in your car but the engine won’t start.
Borrowers with low scores typically have to use lenders that specialize in auto loans for bad credit. Instead of giving up on a car search, stay optimistic amid the difficulty, said certified financial educator Gretchen Seidel, an expert at automotive consulting and financial literacy firm Seidel & Co.
“A score is a snapshot in time; it doesn’t define the person, it’s only their credit profile in that moment in time,” Seidel told The Independent in an email.
Prepare for a pricey loan
A borrower’s credit score is the biggest influence on their car loan rate. The score represents the borrower’s risk; the lower the score, the higher the risk. Lenders protect themselves against that risk by charging a higher interest rate, Seidel said.
What qualifies as a low credit score? The rule of thumb is any score of 600 or lower, Seidel said.
“In our current market, ‘bad credit’ generally refers to a FICO score of 600 and below,” she said. “Lenders look at it as ‘subprime’, which means there’s a higher perceived risk to lend to that person.”
However, some lenders could consider a score of up to 619 as bad credit, according to Ezra Peterson, vice president of insurance and refinance at car education and lending site Way.com.
“A score below 620 – regardless of the credit score model used – is generally going to fall outside the traditional lending market, falling instead to a group of lenders or finance companies that specialize in these higher-risk loans,” Peterson told The Independent by email.
Subprime borrowers get interest rates that are nearly three times as high as those in the top tier (781 and higher), according to CNBC Select.
Save for a down payment
The high interest rates that come with a bad credit score can be costly. However, there’s a workaround, Seidel said. Some lenders may be willing to lower the loan’s rate if the borrower makes a down payment of anywhere from 10 percent to 30 percent.
“Saving for a solid down payment, from 10-30% of the purchase price, shows good faith to the lender and what is referred to in the industry as ‘skin in the game,’” she said. “This means the customer is invested in the vehicle from day one and gives the lender the indication that the customer might not default on the loan even if the credit score is lower.”
A down payment also reduces the amount of money the buyer has to borrow. The smaller loan means lower monthly payments compared to someone who bought the same car without a down payment.
Research lenders
Borrowers with bad credit should keep an open mind about financing and avoid relying on the dealer to find a loan for them, a process that typically takes place if you walk into a dealership without your own financing.
“If you are letting the dealer find the loan, then there is basically nothing you can do to shop for a better interest rate,” said attorney Michael A. Klitzke, CEO of Auto Law Firm.
Getting auto loan financing before you go to the dealership gives you the power to choose the loan that best suits you.
“There are quite a few subprime lenders that will accept people with bad credit,” Klitzke told The Independent.
When comparing loans from multiple lenders, the Consumer Financial Protection Bureau, a federal consumer advocate, suggests that borrowers should focus on:
- Loan amount: Make sure it’s enough to cover the cost of the car you need
- Interest rate: Dictates how much is paid in interest and influences monthly payment amounts
- Loan length: Loans of six to seven years can lower monthly payments, but the borrower will pay more total interest.
“It’s important for the buyer to make an informed decision, stay within their budget, and focus on rehabilitating their credit score, as the opportunity to refinance this vehicle will be available as their credit score improves over time,” Peterson said.
Refinancing is getting a new loan with a lower interest rate to replace the old one. If borrowers can improve their credit score in the first two or three years of their auto loan, refinancing can cut down total interest payments and, in some cases, lower the loan’s monthly payment.
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