Having bad credit can cause difficulties when buying a new or used car if you need a loan.
However, most people with a low credit score have options that will allow them to get the car they want.
About your credit history and why it is important
Just to be clear, anyone who has ever had a loan, mortgage, or credit card has a credit history file. That file is a detailed report of every loan or account a person has had. It shows account details, credit amount, current status and balance, and payment history. If there have been late payments, missed payments, repossessions, bankruptcies, or foreclosures, those are also in the file. Negative information in the file can remain there for up to 10 years.
When you apply for an auto loan, the lender (dealer, finance company, bank, or credit union) will check your credit history to determine your credit worthiness — which is a measure of how likely, or unlikely, you are to keep your promise to repay your loan — based on your past performance.
However, car dealers and finance institutions don’t take the trouble to read your detailed credit report. Instead, they look at your credit score, which is a numerical rating that summarizes your entire credit history.
Based on that number, a lender will make his decision to either approve the loan at the best interest rate, approve at a higher interest rate, approve based on conditions (a larger down payment, for example), or not approve at all.
All lenders are not alike. There are no well-defined rules for how or when a loan is approved or what terms might apply. Where one lender might not approve, another might, particularly if your credit score is borderline good and not-so-good.
What to do if you have poor credit
First, and most importantly, you should know your latest credit score. Don’t get surprised by a car dealer or finance company that knows more about you than you know about yourself. It’s easy to get your score from an online credit information provider. Get your Experian Credit Report FREE at freecreditreport.com.
Here are a number of strategies you may be able to apply if you have less than perfect credit.
1. Apply for your loan at different sources. Car dealers aren’t the only places to get a loan. Banks and credit unions also make new and used car loans. Online sources such as Auto Credit Express and CarsDirect, are also available.These companies specialize in providing loans to people with “subprime” credit. In fact, get free quotes from each so that you’ll have the choice of selecting the best rate.
2. Make as much down payment as you can afford. A higher down payment reduces your loan amount, which reduces the risk of loss to a bank or other lender. A down payment can also reduce your interest rate in many cases.
3. Shop for the lowest car prices – Lenders look at what is called a loan-to-value ratio. They want to make sure the loan amount doesn’t exceed the actual value of the car. They use a “blue book” that is similar to NADA Guides or Kelley Blue Book to determine value for used cars. The smaller the loan amount relative to a car’s value, the less the lender’s perceived risk. Therefore, if you buy your car at a good price, your reduce the loan-to-value ratio — a good thing.
4. Get a co-signer. Even if you can get approved for a car loan, but with a high interest rate due to having poor credit, getting someone to co-sign with you will improve you chances of getting approved at a lower rate. A co-signer is not a co-owner. It’s simply someone with a good income and credit score that will agree to make your car payments when you can’t. This is also a great way to improve your credit score, assuming you make all your payments on time.
5. Pay cash. If you can raise the cash to buy your car, you won’t need a credit approval and your poor credit score won’t be a factor. If you don’t have the cash available, borrow it from friends or family and pay them back as you can. The disadvantage of this method is that it doesn’t help improve your credit score as does having a co-signer.
6. Buy from a dealer who finances his own car sales. In the business, these are known as buy-here-pay-here dealers. They don’t care about your credit since the car is their collateral and payment terms are fairly strict. You can find such dealers in your area, but be aware that their cars are often overpriced and the loan interest rates are very high.
Bad credit is not necessarily a show-stopper when buying a car because you do have options. It’s up to you to determine which option will work best for you.