What’s the first question most people ask when looking for a bad credit car loan: “how much car can I afford?” That’s a good question and certainly one you should know before beginning your search, because you might be surprised how much car you actually can afford. While this process can be fairly straightforward if you have decent credit, it can be intimidating for people who are considered to have bad credit. This is not to say that you should let it stop you from obtaining a car loan, it’s only to suggest that you will have to be savvier in your search for a car loan. Consider this a challenge, and while it will take some research, the reward is worth the journey. Being informed of the process is especially important when you have bad credit, so let’s take a look at some of the things that will help you along the way.
First, Work on Your Credit Score
It’s always a good idea to work on your credit a little before you walk into a car dealership. Cleaning up what you can on your credit report will help you get a better interest rate and also make you less of a risk in the eyes of the lender. If you can, pay off past due accounts, or dispute credit report errors, do so. Make sure to also pay close attention to your credit in the months leading up to your purchase. This includes paying your bills on time and not taking on any new loans. Be sure to settle any debt collections or tax liens. This will allow you to find a better rate, which will allow you to buy more car, while also potentially lowering your monthly payment.
Check Interest Rates
Before you head out to buy a car, check the latest auto loan interest rates so that you know what to expect when you start negotiating. You might have to settle for a rate above the average, but knowing the rate will give you more confidence when negotiating. For example, if you are offered a rate that is more than double the average, this might not be the best deal for you. Don’t be afraid to shop around for a better rate. If you have good credit, you can expect a rate at or below the current average. Knowing what to expect will help you avoid predatory loans, which can further tarnish your credit report.
Consider a Bigger Down Payment
A good way to offset the higher interest rate and potential limitations on the size of the loan is to make a bigger down payment. This will allow you to widen your search to other models you may not qualify for, while also reducing the interest, taxes, and fees you may incur.
Know Your Budget
Creditors will know your budget, so it’s important you know what they’re looking at. Buying a vehicle with bad credit means there are additional requirements you should be aware of. Lenders will look deeper into your finances to ensure you can afford to make the payments. What they’ll be looking at might surprise you. Income is certainly where they’ll start, but they’ll also be looking at things like residence and employment stability.
If you want to know exactly how much car you can afford, and, more importantly, if you will qualify for a loan, calculate your debt to income (DTI) and payment to income (PTI) ratios before looking for an auto loan. The first thing a lender will do is “debt you out,” and this is something you can do yourself, so there are no surprises. To calculate your DTI ratio, add up your monthly bills, including an estimate for the auto loan, and divide the total by your pre-tax monthly income. Bad credit lenders generally require a ratio of 45–50% or lower to approve you for a loan. This tells them how much of your income is available to pay your auto loan. So, ideally, you want your DTI ratio, which includes your auto loan and insurance payments, to be no more than 45–50% of your gross monthly income.
Now take a look at your PTI ratio. This lets a lender know your maximum monthly payment, and is easy to calculate on your own. Simply multiply your gross monthly income by .20, which is where lenders will generally cap your PTI. So, say you have a gross monthly income of $3,000, your maximum monthly payment would be $600. Of course, it’s better not to max out your monthly payment when you plan your budget.
Knowing your DTI and PTI ratios will give you a good understanding not only of what you can afford and will qualify for, but what makes sense for your budget. When it comes to budgeting for a car loan, remember that the loan is not the only part of owning a car you will need to budget for. In general, it’s recommended to not spend more than 10% of your take-home pay on a car loan, with no more than 20% on total car expenses, including gas, insurance, and maintenance.
Shop around and find the best interest rate for your car loan. If the rate isn’t right, or if you are unable to get approved, keep looking. Not all lenders have the same requirements, so it’s important to try more than one lender. Just be aware that any time a hard inquiry is run on your credit, your score can be negatively impacted
Find the Best Car for Your Situation
You might be tempted to ask about the luxury car with high mileage—the shiny car parked up front on display, just begging you to buy it. Try to resist these temptations. You will want to find a car that will last for years while you rebuild your credit. This is important because you might not be in a position to trade up for a few years and will be stuck with the car you choose for a while. If you buy a car that might have more maintenance and upkeep involved, the process of rebuilding your credit might take longer if you have to pay for expensive repairs.
Consider a sensible car, such as a compact with low miles and a good reputation for reliability. The lender will also take this into consideration when they determine your eligibility for a loan. They are more likely to approve you for a loan if you’re looking at a sensible car then they would if you are looking for something less practical, even if both cars have the same sticker price. Remember, bad credit can be temporary, so while the sensible car might not be the car of your dreams, it can be your ticket to good credit, which will open up many more options down the road.
A New You
Now that you’ve found the perfect car for your situation, go out and get it! You know what to expect and have your eyes set on the road ahead, looking toward a bright future. Knowing what to expect is the most important part of your car search, so now you can relax and take the time to find the car that will position you for success.