Getting a Car Loan with Bad Credit

One number can make or break a consumer’s financial options. A credit score ranges from 300 to around 850 and is used to determine an individual’s credit risk or creditworthiness. Higher scores typically correlate to better loan terms and interest rates, while those with lower scores could possibly be denied loans or face higher interest rates.

Lenders might be cautious about extending credit or offering loans to those with lower credit scores. When shopping for a new or used car, higher-risk borrowers can still find some loan options. While getting a car loan with bad credit isn’t impossible, consumers might need to research their choices to determine the ideal loan for their financial situation.

Understanding the Credit Score

Some individuals have no idea about their credit score and what it means for their potential in securing a loan. Consumers can use sites like CreditKarma to review their scores; these scores might not mirror the scores viewed by lenders, but the scores on sites should be similar.

What denotes a good, fair or poor credit score? Equifax explains that a score of 800 and higher is “excellent,” scores that range from 799 to 740 are viewed as “very good,” and a “good” score is one that falls between around 670 to 739. The credit bureau notes that a score of 669 to 580 is deemed “fair.” Anything from 580 and lower is considered to be “subprime” which is a term used to describe scores that correlate to higher risk.

How the Credit Score Impacts Rates

Individuals with high credit scores will be perceived as less of a risk by lenders. This is due to the fact that a high credit score can be achieved by paying debts on time, mixing up credit types (meaning other lenders have extended credit) and having a long credit history, too. A low debt-to-credit ratio also helps the score; a credit card with a high limit and $0 balance, for example, would help improve the individual’s ratio.

When an individual presents less risk to the lender, they might be offered lower interest rates for their loan. The lender feels more confident that they will be paid back on time and the loan will be less likely to fall into default.

Those who have a low credit score present a financial red flag to lenders. These individuals might have filed for bankruptcy in the past, have delinquent accounts in collection and might also have a larger credit debt compared to the amount of credit extended to them. The low score is a red flag because if the individual has poor financial habits, the lender faces more risk in extending them a loan or credit.

An individual with a low score could be at a greater risk for defaulting on the loan, paying late, etc. While this isn’t always the case, the lender can only judge an individual’s creditworthiness or risk by their scores and the credit reports. If an individual is deemed to be a credit risk, the lender might approve a loan but could impose higher interest rates. Some lenders might deny a loan as they believe the financial risk is too high.

Rates for Good Credit Scores vs. Bad Scores

A bad credit score is 580 and lower. These scores place the consumer in the subprime category. Again, an individual with a low credit score might still be able to get approved for a loan but they could face a higher interest rate. How high the rate can soar might depend on the lender, the market and even the loan terms.

Back in October, Car and Driver published an article about the potential interest rates for a car loan related to credit score. The highest credit scores correlated with a low-interest rate of around 2.96 percent for a new car, while the site explained that those with poor scores could see rates from around 9.75 to more than 12 percent for a new car. Borrowers with low scores who opted for a used car faced rates that were much higher—16.85 percent to more than 20 percent.

Since the article was published, the Fed has yet again bumped up interest rates and the rates for everyone might be higher now. As the Federal Reserve has bumped up interest rates, the rates that consumers receive from lenders also rise.

Where Can Individuals with Poor Credit Find a Loan?

While individuals with a poor credit score could opt to apply for a loan through a car dealership or a local bank, what if they are denied by standard lenders? Are there any other options to find financing? Some car dealerships are known as Buy Here, Pay Here (BHPH) dealerships; these dealerships act as their own lender and often accept buyers with poor credit or no credit.

BHPH dealerships sell used inventory. Their cars might be priced higher, and the interest rates are higher, too (because of credit risk). In addition, Experian explains that those who purchase at a BHPH dealership need to make a larger down payment, and these dealerships show buyers the cars they can afford to purchase.

BHPH dealerships might require buyers to make payments more frequently. These dealerships also could install a device that blocks the ignition if an individual is late on making a payment. For those considering a BHPH dealership, review the terms, payment obligations and interest rate. 

Individuals with Poor Credit Could Consider Paying for a Car Outright

High-risk borrowers might find that they don’t qualify for a standard loan at a dealership and they also might not wish to take on a loan via a BHPH dealership. There is another option for purchasing a car, though.

Saving a few thousand dollars for an older vehicle and buying it outright could be an option that allows the buyer to have a car they need without committing to a high-interest loan. Buyers will need to begin saving money for their purchase and research cars in their price range.

While the price of new cars is slowly starting to fall, prices might still seem high. However, there are low-budget options in many areas. A low-priced car, though, could be older or a high-mileage vehicle. Some might be in poor condition.

As with any car, buyers should visit the dealership and inspect the vehicle. Take a test drive and ask to see a Carfax, too. The Carfax will note the number of previous owners and will include any accidents and repairs, too (if applicable). Buyers also could request a third-party inspection to better understand any issues with the vehicle.

Understand that Longer Loans Might Not be Cheaper

When a low credit score bumps the interest rates higher, car buyers might research loans that offer a longer term to keep the car payments affordable. A longer loan (e.g.75 months) could be more affordable per month, but the buyer will pay more in interest over the life of the loan.

Those who are considering a longer loan term also need to understand the potential impact of depreciation. Simply driving the car out of the dealership can lower the value by nine to 11 percent; over five years, a car will lose even more of its value.

A longer loan could mean that the car owner is underwater (which might also be referred to as ‘negative equity’), as the value of the vehicle is less than the loan balance. Allocating a larger down payment (20 percent) for a new car could keep the car owner from falling into this financial scenario.

How to Research Loan Options

When searching for a used or new car, buyers also might be able to research financing options, too. Some sites—including LoanCenter—let buyers review their options for car loans. Choose to get pre-qualified for financing to better explore and understand loan choices, terms and rates.

Getting pre-qualified is not the same as being pre-approved. A pre-qualification is considered a soft credit inquiry; this means that there isn’t an impact on an individual’s credit score. Getting pre-approved, though, requires more information from the borrower including a social security number, and this option also will slightly impact the credit score.  

However, before shopping for a car, buyers should review their budget to better understand how much they can comfortably spend per month on a car payment. Nerdwallet recommends allocating less than 10 percent of monthly take-home pay on a car payment.

Car buyers with bad credit might worry about finding a loan to finance their vehicle purchase. While some lenders might not wish to take on the risk of a subprime borrower, other lenders might approve a loan (albeit with a higher interest rate). However, borrowers should research their credit score before embarking on their car shopping journey; in addition, buyers also should review their budget to understand how much car they can afford so they don’t overextend their finances. When considering loans, review the monthly payment costs, the interest rate and the loan term, too.