Buying a Car with Bad Credit

April 2016

Is your credit score keeping you from getting a new vehicle? Having bad credit brings concerns of whether or not you can afford a reliable vehicle, get a loan at a reasonable rate, and avoid pressure from lenders. Though these concerns are realistic, it is important to know that most people in this situation are able to find a reliable vehicle and a loan that doesn’t break the bank. To do this though, you have to do your homework to understand the right steps to take. This report will show you those steps and will help you understand what you need to know to get the vehicle you need.

The Hard Facts About Being a Buyer with Poor Credit

Many lenders will consider buyers with a credit score between 660 and 620 on the FICO scale as having poor or bad credit. Having a poor credit score means that you will pay a higher interest rate on an auto loan, compared to buyers with good or excellent credit scores. This is the case with even the best lenders. With concerns that they will not qualify for an auto loan, many buyers with poor credit will settle for a lender offering the highest interest rates possible. Playing off the buyers fear, some lenders will also pressure borrowers to sign for a long-term loan of six or more years, highlighting lower monthly payments, rather than the higher total cost of the loan. There are also lenders that will insist that the borrower with bad credit purchase add-ons, such as extended warranties or credit insurance – even though these are not legally required.

The following approach can help you avoid these expensive traps and get an auto loan you can afford, even with poor or bad credit.

Five Steps to Success

  1. Know your credit score and check your credit report for errors.
  2. Estimate your car buying budget.
  3. Identify several potential vehicle models that fit your estimated budget.
  4. Start with your credit union for your best financial deal.
  5. With an approved loan in hand, shop for the vehicle.

The Ideal Solution: Rebuild Your Credit Before You Buy

The best approach is to take time to improve your credit before you start shopping for a new car. Unless your current vehicle requires repairs that are not within your budget — or the vehicle no longer operates, take six months to a year to improve your credit score. By doing this, it will allow you to buy a more reliable vehicle, with a lower interest rate on the auto loan. [See this Remar's Report on improving your credit score.]

But for this report, let's assume that you have no choice but to get new wheels.

Five Steps to Success

1. Know Your Credit Score and Check Your Credit Report for Errors

No matter what you think your credit score is, you will not truly know unless you check. To check your credit score, first find out if one of your credit card providers offers a credit check at no cost. If they do not, you can request a credit check during your free annual credit report for a small fee (see below). Your credit score is based on the information contained in your credit report.

Generally, a credit score below 660 and 620 makes you a "subprime" borrower to most lenders. Different lenders use different credit score models, but most use FICO Score 8. FICO Score 8 is the same as the regular FICO score, but contains slight modifications to meet certain auto lenders’ requirements. Factors that contribute to lower tier scores include:

  • Having too much new credit
  • Carrying high balances or being close to your credit limits on credit cards
  • Making slow or late payments
  • Having changed jobs or residences, particularly more than once, in recent years
  • Having any collections on your credit report
  • Having a recent bankruptcy—a big negative mark

To ensure that your credit score is accurate, check your credit report carefully for errors and have all errors corrected. You can go to www.annualcreditreport.com to request your free annual credit report (as mandated by federal law) from any of the three big credit reporting agencies, Equifax, Experian, and TransUnion.

2. Estimate Your Car Buying Budget

Before you identify a vehicle you like or start shopping for a loan, you need to have an idea of how much money you can afford to spend on buying and owning a vehicle. If you think you can afford any vehicle, as long as you can afford the monthly payment, you are about to dig yourself into deeper financial trouble.

A monthly payment does not buy a vehicle; it buys a lump sum of money. How much money your payment buys also depends on what interest rate you pay and how long you finance your vehicle. If your credit is bad, you will pay a higher interest rate. Borrowing for a longer term also raises a loan’s interest rate, so plan to finance for no more than 48 months for a used car or 60 months for a new car. Also keep in mind that in addition to making a loan payment, you also need money for gas and regular maintenance.

When buying a car, most lenders will expect the borrower with poor credit to pay a down payment. The most common suggested minimum amount is often one thousand dollars. Cash is better than equity in your present vehicle.

We suggest that you estimate your budget this way:

    • What down payment do you have? _______ Cash (plus any equity in your present vehicle).
    • What monthly payment can you afford? _______
    • How much total cash will your preferred monthly payment buy? _______

      To estimate this figure, use our auto loan cash calculator. Using your proposed payment, calculate how much cash your payment will buy at 14% for 60 months for a new vehicle and 16% at 48 months for a used vehicle. Depending on your individual situation and lender, you may be able to find a loan at a lower Annual Percentage Rate (APR), but these interest rates are adapted from recent averages for all borrowers with bad credit.

      Example: If you can afford to pay $300 monthly, the cash from your loan would be:
      • New car for 60 months at 14%: $12,893
      • Used car for 48 months at 16%: $10, 586

 

  • What is your total estimated cash? _________
    (To get this figure add your down payment to the cash from your loan. Remember, this amount has to cover the cost of the car plus taxes and fees and any add-ons.)

3. Identify Several Potential Vehicle Models that Fit Your Estimated Budget.

Don’t start shopping online or at a dealership for an actual vehicle. In this step, you only identify models that meet your needs and budget. A used vehicle with a record for reliability will represent the best value for most buyers with poor credit. Consumer Reports' list of best used car values may help you identify some models. Have your list handy when you apply for a loan because many lenders will wish to see what type vehicle you intend to buy.

4. Start with Your Credit Union for Your Best Financial Deal

Yes, the next step is to shop for your best financing opportunity before you shop for a specific vehicle. Start with your credit union. Overall, credit unions offer very competitive auto loan rates. In many cases, their rates for used cars are much lower than many other lending sources.

If you have poor credit, your credit union may be more likely to offer you a loan because of your ongoing relationship with them. Make an appointment with your credit union to apply for a loan and bring in the following documents:

  • Your driver’s license
  • A recent pay stub, to verify your income. Be sure to note how long you have been employed at this job and take the phone number of your employer in case the lender wants a reference.
  • A recent utility bill. This confirms your current address, in addition to your driver's license. Be prepared to say how long you have lived in your residence and whether you own or rent. Lenders take stability into their decisions.
  • Your estimated budget.
  • Your shopping list of vehicle models.

If the credit union approves a loan for you, you are ready to shop for an actual vehicle. You also have an approved loan with terms that you can compare to other offers you may receive. If the credit union is unable to approve a loan, ask what credit factors you need to improve.

You can also use the information you gathered to apply for a loan with a dealership. Multiple credit requests made in a short time (such as 14 days) for one thing, such as an auto loan, will not lower your credit score further.

Tip: Avoid specialty subprime lenders and "buy here, pay here" sales outlets. Although there are multiple lenders who specialize in subprime loans (many online), you can expect to pay higher rates. The less reputable lenders may pressure you to sign up for longer terms and to buy add-ons that you don't need. If you absolutely must buy a car and such a lender is your last resort, negotiate for the best terms and plan to refinance with your credit union when you have a track record of 6 to 12 months of paying on time.

5. With an Approved Loan in Hand, Shop for the Vehicle.

When you have an approved loan in hand, you are ready to shop for a specific vehicle. Look for vehicles online at local dealerships. If you are buying a used vehicle, be sure to use the VIN number to check the vehicle’s history, using a service such as CARFAX. In addition, have an independent mechanic or diagnostic service check out the vehicle.

When you find a vehicle, negotiate up from wholesale value (used vehicles) or dealer’s cost. Resist pressure to buy add-ons, no law requires that you have them to get a loan. If you think you may need an extended warranty/service contract for a used vehicle, check out those offered by your credit union—you can usually get more for less money.

Bad Credit Does Not Equal "No Hope"

Just because you have poor credit and are fighting to rebuild it, don’t assume that you cannot qualify for an affordable car loan. Get your facts together, build a potential budget, and talk to your credit union first. Your credit union can help you make decisions that are right for you.

For More Information

StraightTalk Auto Issues

Remar’s Report: What Is a "Credit Score" And How Can It Affect Your Credit

Remar’s Report: Tips for Improving Your Credit Score

Consumer Reports offers extensive information on used and new cars. Online subscription is $$.

 

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