What is a bad credit car loan? Why is your credit score so important? What’s an interest rate? These are common questions you might ask after discovering your credit score isn’t high enough to qualify for a traditional car loan. As if buying a car isn’t already stressful, now you’re faced with finding another option that will hopefully get you behind the wheel of a reliable vehicle you can afford.
While navigating the seemingly endless cycle of bad credit can be overwhelming, it isn’t impossible. Bad credit car loans are viable options designed to help you finance your purchase and, in many cases, rebuild your credit. How so? Here’s everything you need to know about bad credit car loans, your credit score, and interest rates as you shop for your next vehicle.
Prime vs Subprime Borrowers
Do you know your credit score? This three-digit number determines your creditworthiness and will follow you throughout your adult life, particularly when it’s time to make big purchases or secure a loan. Your credit score is determined by several factors, like payment history, credit history, credit utilization, your mix of credit, and credit inquiries. Each component impacts your score differently, with payment history making up 35% of your score and having a much more significant impact than hard credit inquiries, which account for only 10% of your score.
While credit scores range from poor to excellent, the scores classify individuals into two broader categories: prime and subprime borrowers. Prime borrowers have high credit scores and qualify for traditional automotive loans and lower interest rates. Why? They’ve proven they can responsibly handle their debt, making it less risky for a lender to agree to a loan.
In contrast, subprime borrowers have low credit scores or limited credit histories. This is usually, but not always, caused by a record of late payments, bankruptcy, or defaulting on prior loans. While your bad credit might be the result of factors outside your control, most lenders consider subprime borrowers too great of a risk and either decline the loan or approve it with an astronomical interest rate to mitigate the risk.
Bad Credit Car Loans: The Answer to Your Subprime Woes
When you work with a traditional dealership, you rely on their finance department to help finalize the sale and secure financing. Most dealerships have working relationships with several major lenders, but those lenders usually require high credit scores for approval. These stringent requirements leave subprime borrowers empty-handed.
A traditional dealership doesn’t have the capacity to work with buyers with low credit scores. But does that mean all hope is lost? Fortunately, it’s not the end of the road because a bad credit car loan can solve your subprime woes. How so? It means working with a dealership skilled in these situations, and it gives you the opportunity to rebuild your credit one payment at a time.
A bad credit car loan works much like a normal car loan because you’re borrowing money from a lender to purchase a vehicle. However, your low credit score makes you a greater risk for the lender. As expected, the lender mitigates that risk by charging a higher interest rate and, sometimes, additional fees. For example, a lender may charge a 3.5% interest rate on a prime loan but set a 25% interest rate on a bad credit car loan.
How to Prepare
Before you navigate the car-buying process and apply for a bad credit car loan, it’s essential to do your homework. First, look at your income and expenses to determine your budget and how much you can spend on a vehicle each month. If your expenses exceed your income or you have little money left at the end of the month, look for ways to save money that you could use toward a car payment. If you’re in a situation where you have money left over each month, consider setting some aside for your down payment.
Once you have an idea of your budget, take advantage of the bustling used car market to look at models, weigh your options, and run the numbers. By window shopping, you can get a better idea of the type of vehicle you need, the features you consider must-haves, and those you can live without. Then, as you narrow your options and finetune your search, continue saving for a down payment and start looking for a reputable dealership that works with subprime borrowers and offers bad credit car loans.
What to Expect
Dealerships that offer bad credit car loans aren’t like traditional dealerships that encourage you to browse their vast selection to upsell you a more expensive model with every feature imaginable. Instead, most dealerships that are well-versed in working with individuals with low credit scores do things differently and start with the finance process. Why is this important?
While you’ve already done your homework and know what type of model you want, it’s essential to understand what you can afford before officially starting the purchase process. Dealerships specializing in bad credit car loans begin with the approval process by verifying your income, evaluating your credit score, and considering your down payment. With this information, the dealership can help you navigate the approval paperwork and offer guidelines on improving your chances of approval, whether by securing the loan with collateral or finding a cosigner.
Once you’re approved for a bad credit car loan, the dealership team will walk you through your options and show you the models that fit your budget. By reversing the process, you can confidently make your purchase because you know what you can afford to spend. It’s like going into the mall knowing you have $500 to spend versus finding the latest designer bag only to discover you have $250 in your bank account.
Breaking the Cycle With a Bad Credit Car Loan
While having a high enough credit score to qualify for a traditional car loan is ideal, it’s unrealistic for many people. Major lenders can be difficult to work with, setting strict standards and unattainable loan requirements. The alternative is a subprime loan with a higher interest rate and additional fees. However, these types of bad credit car loans are not always bad and offer a beacon of hope.
A bad credit car loan makes it possible for subprime borrowers to secure financing and purchase a reliable vehicle. This automatically puts the borrower in a better position because they can positively impact their credit by making payments on time. For example, most dealerships that offer bad credit car loans report loan activity to the major credit bureaus. As a result, every payment you make will positively impact your credit score, helping break the cycle of bad credit that once seemed endless.
As you shop for your next vehicle, remember that a bad credit car loan is a viable option that can put you back on the road to financial recovery. By budgeting ahead of time and working with a reputable dealership, you’ll discover that having a low credit score and buying a vehicle aren’t mutually exclusive. Bad credit car loans prove otherwise, helping you reestablish your creditworthiness one payment at a time.
