Editor's Note: This article was originally published on 02/27/18 and updated.
Getting a car loan with bad credit might seem impossible, but it's not. People with poor credit get approved for car loans all the time, and while it might seem challenging, you can take some steps to increase your chances of getting the loan—and the car—you need.
Credit scores are one of the factors lenders consider when deciding whether to offer you a car loan. FICO® Scores, one of the most commonly used credit scoring models, range from 300 to 850. On that scale, a score of 669 or below is considered fair or poor. With a score like this, you may not be eligible for all loans—but with proper planning and research, you should be able to find a loan that works for you.
Steps to Take Before Applying for a Car Loan
1. Check Your Credit Scores—and Improve Them If You Can
A smart first step before making any major purchase or applying for a loan is getting a free copy of your credit reports. Checking your credit reports and scores gives you an idea of where your credit falls on the spectrum of excellent to poor. This way you can apply with confidence for loans geared to your credit profile.
If you don't need a car immediately, working on improving your scores before applying for a new loan may help you get better terms and a lower interest rate—which should save you some money. Here are a few tips for improving your credit scores:
- Pay all your bills on time. Also, pay off any missed or late payments or accounts in collections. Payment history is one of the most important aspects of your credit and is one of the best ways to improve your scores.
- Reduce your debt as much as possible. This not only puts you in a better financial position when applying for a loan, but it also improves your credit utilization ratio. Your utilization ratio is calculated by dividing your total revolving credit balances by your total credit limits. Experts recommend keeping your utilization ratio under 30%, or below 10% for the best scores.
- Check your credit reports for errors. These problems might be weighing your scores down. Mistakes happen, and removing any inaccuracies from your credit reports could help improve your score.
- Take advantage of tools like Experian Boost, a new platform that will allow you to improve your score instantly by adding utility and phone bills to your credit file. Experian Boost will be available in early 2019, but you can visit experian.com/boost now to register for early access.
2. Research Different Auto Lenders
If you've had trouble getting approved for loans from conventional lenders, take a look at lenders that focus solely on serving people with lower credit scores. These lenders typically offer loans at higher interest rates, but they can help people with poor credit scores who need to get a car in a pinch.
Be on the lookout for car dealerships that indicate they work with people who have bad credit. These dealerships may have agreements with lenders who are committed to working with subprime borrowers, or they might finance your loan themselves.
To find auto lenders you might be able to work with, search online and look through Experian's auto loan partners, some of which offer loans specifically for people with bad credit.
3. Make Sure You Have Enough Money for a Down Payment
If you can put money down toward your new car loan, you may be able to lower your monthly payments, get a better interest rate or shorten the term of your loan. Even though you may have poor credit, a down payment is money-in-hand that a lender will take into consideration when weighing the risk of giving you a loan. Saving for a down payment can make the difference in getting approved for the loan you need.
4. Know What You Can Afford
Make sure you have an idea of what monthly loan payment you can afford, as this will help you choose a car in your price range. At the same time, research current average car loan interest rates so that when it comes time to negotiate, you have an idea of what you can afford. You can research current rates online or browse through Experian's auto loan marketplace to get an idea of the current terms and interest rates available.
Options for Getting a Car Loan With Bad Credit
If you need a car immediately and don't have time to improve your credit scores before applying for an auto loan, here are some alternatives that might help.
1. Consider Getting a Cosigner
Having a cosigner with good credit can increase your chances of getting approved for a car loan and may help you get a better interest rate. When a cosigner applies for a loan with you, they are essentially telling the lender that if you don't pay back your debt, they will.
Because the lender has someone else to go to if you default on the loan, there is less risk involved and you're more likely to be approved. With less risk, the lender may also offer you a lower interest rate—which could save you thousands over the life of the loan. Remember that this new debt will appear on both your and the cosigner's credit reports, and any missed or late payments could impact both your scores.
Having a cosigner can be very helpful when trying to get a loan with bad credit. Just be sure to make all your payments on time so you don't put your—or your cosigner's—credit scores at risk.
2. Try a Buy-Here-Pay-Here Dealer
In this scenario, you not only choose the car at the dealer, you finance it there as well. As opposed to a conventional sale where you use a third-party lender, in this case, the dealership itself is the finance company. The decision to approve your loan is made by the same entity that is profiting from the car sale, so they are often more flexible in giving financing to people with poor credit scores.
While these types of loans may be good for someone with bad credit who needs a car loan quickly, consider these pitfalls: Interest rates are typically much higher with dealers than with other lenders, there may be specific payment instructions requiring you to pay in person, and if you miss payments there could be a higher chance of the car being repossessed. Unfortunately, many of these lenders do not report these accounts to the three credit bureaus, so you will not be able to use these types of loans to build credit. If you're unsure, ask whether they report to the credit bureaus.
3. Find a Second-Chance Car Loan
These types of loans do exactly what they say and are meant specifically to give people with bad credit a second chance. If you have been turned down for a conventional car loan, a second-chance lender will try to provide you with finance options you are almost guaranteed to get approved for.
While second-chance loans may be a good option for someone with bad credit, they can also come with certain caveats that diminish their appeal, like higher interest rates and fees. You can search for these types of loans online and can browse through Experian's auto loan marketplace to find ones specifically made for people with bad credit.
4. Check with a Credit Union
Regardless of whether you are already a member of a credit union, you might consider financing your car purchase with one, as they are known to offer loans with good terms and low interest rates. They are also known for working with people that have bad credit.
Check with a credit union—try starting with one that is associated with your employer or a professional organization to which you belong—to see if you can get a pre-approval for a loan before you head to a dealership. This way, you can shop for your car with more confidence and know exactly what you can afford.
Membership to certain credit unions might be restricted depending on where you live, your employer, or any other groups you may be affiliated with. If you are unsure if you are eligible for a membership to a certain credit union, contact them and ask for information about their requirements.
How a Car Loan Impacts Your Credit
Getting a car loan will impact your credit, and the effects could be either good or bad depending on how you handle your repayment.
Your new loan account will be listed in your credit reports, and most lenders will report your payment history to one or all of the three major credit bureaus. Your payment history will also become part of your credit report, so it is important to make all your payments on time.
Payment history accounts for 35% of your FICO® Score, and missing even one payment could negatively impact your scores. Too many missed payments could also result in your car getting repossessed by the lender.
If you make all your payments on time, this positive information will be recorded in your file and will contribute to the overall health of your payment history—helping your scores over time. If you don't know what your credit score is, you can get a free copy of your reports from Experian.
Want to instantly increase your credit score? Experian Boost™ will be available in early 2019 and helps by giving you extra credit for the utility and mobile phone bills you're already paying. Until now, those payments did not positively impact your score.
This service will be completely free and can boost your credit score fast by using your own positive payment history. It can also help those with poor or limited credit situations. Other services such as credit repair may cost you up to thousands and only help remove inaccuracies from your credit report.
Editorial Disclaimer: Opinions expressed here are author's alone, not those of any bank, credit card issuer or other company, and have not been reviewed, approved or otherwise endorsed by any of these entities. All information, including rates and fees, are accurate as of the date of publication.