Car Buyer Labs

Car Buying Advice, Tips, and Reviews

A women doing a monthly budget to help fix her credit

A Realist’s Guide to Subprime Car Loans

In terms of expense, the purchase of an automobile is (for most people) second only to the purchase of a home. And while most of us would love the financial freedom to drive the vehicle of our choice off the dealer’s lot on a whim, cash paid, it’s simply not a feasible option for the average person. In fact, nearly half of the adult population of the United States is currently saddled with auto loan debt. But of those, how many are burdened with bad credit car loans as a result of financial disqualification by traditional lenders? It’s a valid question, but let’s not get ahead of ourselves…

It was reported last year that approximately 107 million Americans were financed in their current vehicles. This increase from 80 million Americans in 2012 represented a staggering jump, exceeding even the number of those who were financing homes at the time. That said, topics of lending and credit-worthiness for vehicle purchases are far more universal than ever before. Especially considering the fact that 6 million Americans are 90 days or more behind on their auto loan payments. With that in mind, it becomes easier to visualize just how many people might be burdened with a subprime credit score.

As of this new year, the national average interest rate for a five-year new-car loan is around 4.9 percent, and for a three-year used car loan the average is around 5.54 percent. And while that’s all fine and well for those with healthy credit scores, the simple truth is that a surprisingly large number of people would never qualify for such lending rates

Putting that last part into perspective, there’s a relatively small portion of Americans who are shamed by terrible credit scores, but nearly a third of scoreable Americans place their subprime scores below 601. That’s somewhere around 68 million people with fair-to-bad credit. That’s 68 million scoreable American adults who may need to find alternate means of securing financing in order to buy a car (more than three times the population of Florida, and almost twice the population of California).

How does this translate? Imagine a 60-month loan for $20,000. Someone with a prime FICO score in the 720-850 range might get approved for a 3.6% APR equating to a monthly payment of $365. However, someone with a 500 score might only be financed at a 15.24% driving the monthly payment up to $478. And while the 3.6% equates to a grand total of $1,884 in interest paid, the 15.24% equates to a staggering $8,699 in interest paid. In other words, it’s more than a number. The FICO score is simply the consumer-facing classification, but the results of that score are very real and really impactful on peoples’ lives.

So, returning to the topic-at-hand, there are a number of inherent risks in subprime lending. Unless you’ve been living under a rock for the last decade, you’re familiar with the ramification of predatory lending in both small and large scale. In terms of the former, a bad credit loan gone wrong can shatter the financial security of either an individual or family. In terms of the latter, the ripple was able to gain so much momentum that it contributed to the crippling of our global economy during the most recent depression.

But it’s important to recognize that not all bad credit car loans are predatory in nature. Many exist solely to assist the underserved – and yet most manage to be lucrative. Recognizing just how numerous subprime credit scores are, a lender can offer financing at a higher-than-average interest rate, compounding their profits exponentially based on the sheer volume of loans offered. And that shot at profitability has encouraged the formation of more and more subprime auto lenders. In turn, it’s more important than ever for a car buyer to understand the terms of a loan contract before signing one, so that they can determine whether or not the lender is reputable. But first, it’s important for every subprime car buyer to engage in as much research and introspection as possible. So here are some thoughts on steps that should be taken long before you dare to set foot in a car dealership.

Understand Your Credit Report

There are a number of tools which have been made available to help consumers monitor their own credit report. For starters, each of the three major credit bureaus are required (by law) to provide you with a copy of your credit report, at no charge, once per year. However, there are a number of consumer sites that one can subscribe to in order to view their Equifax, Experian and TransUnion, separately or combined. These are also a helpful tool in identifying any discrepancies that should be resolved prior to pursuing any lending, or even searching for a vehicle.

Establish a Realistic Budget

Whether based on monthly payments or total cost (different experts might tell you to base your strategy on either) it’s important to understand what you can afford. Bottom-line, if you’re in need of subprime lending options you’re already facing some financial struggles. Overextending yourself further can only do further harm.

So, first…know what you can afford. Secondly…use the various car payment calculators available online to determine where your payment might fall. Since you already have an understanding of where your credit score lies, you should be able to gain an understanding of whether or not certain vehicles fit your budget.

Set Aside Your Wants. Address Your Needs.

Humility and honesty matter when it comes to fiscally responsible car-buying. We all have that perfect vehicle we’d like to get behind the wheel of, and most of us are guilty of overestimating our needs at one point or another. Budget aside, one might seek out “more truck”, “more power”, “more flash” or “more luxury” than we really need. If you’re aware that even an accessibly-priced vehicle will be driven up by the higher APR, it’s important to remain undistracted, focused on your needs.

Factors like the number of passengers, total daily commute (in regard to fuel economy), driving conditions (seasonal or otherwise) and what your needs might be in terms of cargo, towing etc (if any) are valid considerations. You might have preferences in terms of automaker, and most economy automakers will have an offering that suits your needs. It may not be model, style, color or trim level that you’ve dreamt of — but accept early on that your options might be limited.

Limit the Add-Ons

If you’ve managed to compromise, accepting a vehicle which fits your budget (as opposed to your wish list) it can be tempting to upgrade that vehicle, using enhancement packages and add-ons. That said, this is an easy way to drive up a vehicle’s price point quickly. Avoid the temptation.

Read the Contract

A auto dealer finance manager shows customer the paperwork for their bad credit car loan

We’ve touched on this above, but it’s imperative that you understand your financing contract before signing on the dotted line. More than simply APR and Duration, one should understand any penalties, ramifications and risks that could present themselves if the terms of the agreement are violated. From repossession to legal action, failure to understand a contact could place someone in an extremely vulnerable place.

And Most Importantly…

Don’t miss a payment. Common sense? Of course. Unfortunately, there are countless people who secure financing and forget the urgency of their situation once they climb in the vehicle and shut the door.

Between your diligent research and the chance you’ve been given, take the opportunity to build to something better. Use the financing as a stepping stone to improve your credit score, through prompt and on-time payments. Do that and, who knows, the next vehicle might be the one that you’ve been dreaming of.