Buying A Car With Bad Credit: Understanding Your Options

Do you need to buy a car, but your credit isn’t the best? According to an Experian^® 2021 report, the average borrower’s credit score for used car loans in the United States is 665 and increases to 732 for new car loans. If your credit is lower than this, don’t worry. Getting a car loan may be more difficult, but it’s not by any means impossible – we’ll walk through your options and what to expect when buying a car with bad credit.

Auto lenders use credit scores to determine how likely borrowers are to consistently make their monthly payments through the duration of a loan. These auto financing companies consider scores over 581 to be fair or better, while scores under 580 are high risk. While there's no minimum credit score needed to finance a car, you’re more likely to get offers if your score is above 500. 

In order for a dealer to consider you for financing, they will review your credit scores from the three main credit bureaus: Equifax™, Experian® and TransUnion®. Unfortunately, if you have a poor credit score, you’ll likely have limited financing options. Financing a car will likely cost you more upfront and over the course of your loan because lenders are more likely to offer you higher interest rates.

Car shopping with a poor credit rating will most likely get you higher interest rates, so it makes sense to limit the amount you borrow. If it’s possible, try to save more money for a down payment and improve your credit score before applying for a loan. You can save thousands of dollars on interest over the life of a loan simply by taking steps to increase your score before buying. 

That said, if you need a car right away, these tips may help.

Check Your Credit Report For Errors

In addition to keeping an eye on your credit score, you should also look through your credit report periodically. You’re entitled to a free credit report from Experian®, Equifax™ and TransUnion® once a year. It’s important to obtain a copy of your report so you can see what information auto lenders are using to make a decision about your loan. Look for errors, such as accounts you never opened, negative marks about debt that you’ve resolved and other irregularities. If you file a dispute and have inaccurate information removed from your report, your score may increase significantly.

Improve Your Credit

Modest improvements to your credit rating may help you avoid high interest rates. Some of the ways you can improve your credit score include making payments on time for all of your bills each month, paying down your credit card balances, limiting your card usage and avoiding applying for new lines of credit if you know you’ll be looking for a car loan in the next few months.

Pay Cash

While this may not be an option for everyone, it may be worth considering if you need a car quickly and have some savings. If you buy a car with cash, you don’t need to worry about financing. Avoiding a loan also eliminates the financing fees and interest associated with an auto loan. Consider less expensive vehicles that you can pay for with a lump sum payment. Since this limits your possible vehicle pool considerably, it’s not always easy or possible to find something that fits in your cash budget.

If financing a car purchase is your only way into the driver’s seat, it’s even more important to do your research before signing on the dotted line. Auto loans are secured loans, which means that your vehicle is collateral. If you miss payments and default on the loan, the lender has the legal right to repossess your car to recoup their investment.

You’ll also want to be careful and avoid scams or predatory loans that take advantage of you or make it difficult for you to pay off the loan. Here are some tips to help you find the best auto loan when shopping with bad credit.

1. Get Preapproved With Your Bank Or Credit Union

Sometimes, the best way to get approved for a loan is to work with a financial institution you have an existing relationship with. They can review your payment history on your past loans, and if you show that you’re paying your bills on time, they may be willing to forgive any late payments in the distant past.

Getting preapproved is more significant than getting prequalified – it means your lender actually looked at your financial profile and deemed you fit to loan up to a certain amount. Walking into a dealership with a preapproval sets a firm budget for your purchase. From there, you can search for vehicles that fall within your purchase limit and dealers will know you mean business.

2. Avoid ‘Buy Here, Pay Here’ Deals

“Buy here, pay here” deals are loans offered by certain dealerships who advertise with phrases like “no credit, no problem” or “we finance.” They provide loans to people with poor credit but usually at a higher-than-average cost to the borrower. You’re likely to pay stiff processing fees and high interest while also being charged excessive prepayment penalties if you decide to pay off the loan early. These dealerships handle financing differently than traditional dealers, who will work with you and a third-party lender to get you a car loan.

3. Co-sign Your Loan With Someone Who Has Good Credit 

A relative or partner who has great credit can act as a co-signer in order to secure you a loan at a better interest rate. As you make your payments on time, your credit score will improve. A co-signer, however, takes on the liability of the entire loan amount if you default. If your options are limited, this is an excellent way of increasing your approval odds and potentially qualifying for a larger loan. 

4. Put More Money Down 

Auto lenders may be more likely to offer you financing if you provide a larger down payment. It reduces the amount of money you’re borrowing but also shows that you have more invested in the collateral. Some finance companies might only give you a loan if you’re willing to put more down, so consider this possibility when shopping for financing.  

5. Consider Less Expensive Cars 

When dealing with higher interest rates, it’s best to borrow as little as possible. Consider whether you can buy a cheaper car to obtain an affordable monthly payment, and use that loan to improve your credit before your next purchase.  

6. Negotiate On Price 

Many people focus on the interest rate and monthly payment when looking for an auto loan. However, the sale price of the vehicle is the most significant factor when determining how much you pay for a car. If you can get the dealer to come down on price, it can save you a lot of money in interest over the next several years. Use your preapproval letter as a starting point when discussing price with the dealership. 

7. Consider Multiple Offers 

You shouldn’t take the first approval you receive without seeing if other lenders are willing to provide you with better terms. There's typically no extra negative impact on your credit score for applying with multiple lenders as long as all of the credit inquiries occur within a 2-week period.

Cast a wide net and compare the terms of each loan offer you receive to see whether you can get a larger loan amount, longer loan term or a lower interest rate from another lender. Always consider how much interest you’ll pay over the life of the loan. A loan with the lowest monthly payment and longest term may also cost you the most in interest.

8. Look For A Second Chance Loan 

A second chance loan is specifically geared toward people with poor credit ratings. You’re unlikely to get a lower interest rate with this type of loan, but you may be able to use a second chance loan to improve your credit score before refinancing the car loan later.

There may be special requirements for loan approval, such as showing income statements, providing a larger down payment and choosing a vehicle from a limited pool. 

9. Read The Fine Print 

Be wary of extra fees and special terms. Specifically look out for any prepayment penalty terms in your loan contract. This fee penalizes you if you choose to pay off the loan early and could make it more difficult to obtain a better rate in the future when you try to get an auto refinance loan.  

10. Refinance Your Car Later

Just because you can’t get a lower interest loan now doesn’t mean that you’re stuck to the loan term you agree to at the dealership. After making payments for a year or more, your credit score may have improved and you can consider lowering your monthly payments by refinancing.

In order to refinance your auto loan, you’ll need to contact your lender and get a payoff amount. This may include prepayment penalties, so factor all of these costs into your decision. In many cases, lowering your interest rate can offset these fees and save you money compared to remaining in the loan until you’ve made all the payments.  

If you’re worried about how your credit score will impact your ability to obtain an auto loan, the good news is that there are plenty of options for those with poor credit ratings. You may need to pay a higher interest rate, but plenty of lenders will take a chance on you even though your credit isn’t the best.