How To Get A Good Car Loan With Bad Credit

What is bad credit for an auto loan

Auto loan financing standards vary, but in general many lenders define a bad credit score as someone with a score in the low 600s or below. For instance, Toyota Direct states that credit scores less than 660 are considered non-prime and credit scores less than 600 are considered “sub-prime”.

Understanding Score ranges

VantageScore® 3.0 puts credit ranges, from 300 to 850, into several buckets (see graphic below).

Note: Ranges below can help you track your credit score goals, but they don’t necessarily indicate if you will or won’t be approved for credit.

But your credit score will most likely be only one factor in determining your creditworthiness.

Your payment history, overall debt amount, and income level may also play a role in the final lending decision.  Auto lenders likely will consider DTI (debt-to-income) and PTI (payment-to-income) metrics as part of their loan-making process.

Although a bad credit score is a prime indicator of credit risk, there are steps you may take to improve it in the eyes of a lender.

How a bad credit score can affect car loan payments

You can save a lot of money by moving your credit score in the right direction because you’ll be able to get a lower interest rate. Let’s look at a hypothetical example of how your score impacts your auto loan rate, monthly payment and total interest paid.

If you financed a new car with a $25,000 loan for 60 months, you’d pay:

As you can see, a few interest rate points can really add up in higher payments and total interest costs over the life of the loan. In this example, if you were to move your credit score from poor (15% rate) to excellent (5% rate), you could rack up huge savings. You could expect to save over $7,000 dollars in interest on this loan amount.

Note: Increasing your credit score substantially won’t happen overnight. Consistent good credit habits over time may help you achieve a healthier credit history. As you improve your credit profile, your score may improve.

How to improve your chances of getting a car loan with bad credit

Improving your credit takes time, and there is rarely a quick fix. If you need a car right away, the following may be some avenues to pursue to help better your chances at a lower rate or more agreeable terms that fit your current financial situation:

1. Make a larger down payment. Putting down more money upfront may help you find financing more easily. And, when you put more money down up front, you may be able to negotiate a lower payment. Another benefit is smaller monthly payments and more money saved in interest payments. The challenge is you may have to wait to accumulate enough money needed to accomplish this tactic.
2. Get a co-signer. In the eyes of a lender, a co-signer may reduce their risk of lending to someone with bad credit. The co-signer is backup insurance for the lender in case you can’t make the monthly payments. The challenge is you need to find someone who has better credit than you and will agree to take on the risk.
3. Take out a shorter-term loan. For a lender, a longer-term loan carries more risk. A shorter-term loan may lead to easier approval and possibly even a lower interest rate.  The challenge is that the shorter duration loan will come with higher monthly payments which could put more financial strain on the borrower.

Where to find an auto loan when you have bad credit

A car dealership isn’t the only way to finance a new or used car. It’s possible to finance your car through other lenders such as a credit union, online lender or a traditional bank. But which is the best option if you have a bad credit score? Let’s look at your options:

Dealership financing

These options are typically available when you shop for a loan at a car dealer.

1. Dealer arranged financing. In this form of financing, the dealer does all the work in finding the lender. One reason to consider dealer financing is that they may be able to offer deals and incentives directly from the auto manufacturer, such as cash-back deals. Another reason is that they have access to lenders who are able to finance consumers with bad credit. The dealer will submit your loan application to multiple lenders, which will allow you to compare and see which works best for you. But know that the terms of the loan could be less than favorable. Specifically, you may face a higher interest rate than with other options.
2. Captive financing. Some car manufacturers have their own financing companies that finance purchases of the manufacturer’s cars. This is usually only available for new or certified pre-owned models. A benefit of using this kind of financing is simplicity and convenience. And because the finance company is owned by the parent company, you may get a better deal or special interest rate offer on specific car models. The downside could be that the interest rates offered come with a shorter term, making the monthly payments go higher. Also, the captive financing company may not offer attractive rates for bad credit customers compared with other alternatives.
3. Buy Here, Pay Here. Dealerships that offer this type of in-house financing typically work with buyers who have bad credit. They may be able to offer terms that allow for little or no money down. Some of the possible drawbacks of going this route are: higher than normal rates, hidden fees, large down payment requirements, limited selection of vehicles and less leeway with late payments resulting in the potential repossession of the vehicle.

Non-dealership financing

You may be able to get a better rate than through a dealership by exploring these options:

• Getting a loan from a bank. This can be done in person or online. Check out the financial institution that you have an existing relationship with first before shopping for rates and terms with other lenders.   
• Borrowing from a credit union: Credit unions may be a good option, but most require an in-person application for credit. But many credit unions offer lower rates and fees than traditional banks and online lenders.
• Online lenders: These lenders only operate online without any brick-and-mortar presence. There are also websites that may allow you to compare rates based on your credit score.

What to be aware of when applying for an auto loan with bad credit

When you actively begin the process of either shopping for an auto loan through a dealer or one of the other options outlined above, do your best to limit the number of loan applications you fill out.  Applications for new credit are called “hard inquiries” on your credit report and are a factor in determining your credit score. Submitting many new applications for credit could have a negative impact on your score.

Satisfactory Accounts summarize revolving credit accounts and installment loans that are current and in good standing. An installment loan is debt you will consistently pay back over a period of time, such as a mortgage or car loan.  Revolving accounts give access to available credit that can be used as needed such as a credit card.

The Collections section calls out accounts that are significantly overdue. It includes accounts a creditor has sent to an agency to collect debts.  Collection information can include information such as name of the collection agency, account type, original creditor, original balance of collection and current amount owed.

As you make a thorough review of your credit report, check for any personal or account information and inquiries that are unfamiliar to you. Unusual inquiries might be signs of fraud or they could have been inaccurately reported. Make sure to dispute any inquiries you don't believe you initiated, as too many inquiries may be viewed negatively by creditors and may negatively impact your score.

For more details and tips on how to read your credit report and understand the impact the information in it can have on your credit health, check out this interactive guide from TransUnion.

Understand credit score factors

Your credit score is ultimately a reflection of how well you manage your credit. There are many different scoring models; each model and its accompanying versions may weigh scoring factors differently.  When you get an online credit score directly from TransUnion, it’s a VantageScore® 3.0 credit score.

As the graphic shows above, payment history, age and mix of credit and credit utilization make up a large majority of a credit score. Let’s briefly touch on those aspects.

Payment history (40%) is the biggest credit score factor. Consistently making on-time payments for your accounts can help you build and maintain a healthy credit history.

Credit mix and age (21%) is another important factor to examine. It evaluates average age of your accounts and the different types of accounts you have. Having a long history of credit with a diverse mix of accounts can help your score.

Another key element is credit utilization (20%), which is how much of your available credit limit you’re using. Lenders may evaluate utilization rate to determine creditworthiness, with the higher the utilization rate, the riskier the borrower is typically seen. Try to reduce your overall debt and get your credit utilization rate at or below 30%. 

Note: Closing accounts can affect your credit score, but the impact can vary depending on several factors. Be careful when closing a longstanding account, as your credit score could drop. That’s because as your total available credit decreases relative to current reported balances, your utilization goes higher. Also there is an impact on overall credit age if you close a long-standing account which can lower your credit score.

Monitor your credit

While there isn’t a quick fix to improve a bad credit score significantly in the short run, it can make sense to look at ways to improve your score out into the future that can help you get ahead in life and save you time and money. One way is to check your free annual credit report to check for any inaccuracies. Another option is to get year-round credit score and report monitoring.