How to get a car loan with bad credit

Liz KnuevenMar 5, 2020, 19:34 IST

To get a car loan with bad credit, start by saving a down payment, checking your credit score, and setting a budget.
Then, shop around for loans and choose an offer. Anyone buying a car with bad credit should consider saving more for a down payment, or consider finding a co-signer.
Buying a car with poor credit will cost more in interest, so it may be worth waiting and working to raise your credit score if possible.
See Business Insider's picks for the best auto loans »

Buying a car with bad credit could mean that you'll spend a bit more to borrow.

The steps will be largely the same - you'll still want to shop around for your loan and compare offers, and get your car the same way. But, with poor credit, getting a car loan will cost you more, as banks will charge higher interest rates to lend to you.

Generally, people with good credit scores between 661 and 780 see interest rates about 3% lower than those with scores between 601 and 660, as Business Insider's Tanza Loudenback reports. To combat this, you might want to consider waiting to buy to improve your credit, saving a larger down payment, or finding a co-signer.

Here are the seven steps to take to get an auto loan, even with less-than-perfect credit.

1. Save up a large down payment

To get a car loan with bad credit, start by saving a down payment. Generally, a 20% down payment is recommended for a car purchase. But to buy a car with poor credit, the larger down payment you have, the better.

Making a large down payment can help you get approved for your loan easier. The down payment helps to decrease the amount you'll owe compared to the car's value, also called the loan-to-value ratio. The more you can save for a down payment, the less risky banks will see your purchase.

2. Check your credit - and improve it if you have time

Your credit score is like a lender's version of a GPA. It's a three-digit score that falls between 300 and 850, and looks at your borrowing, payment, and credit application history.

Well before you need a loan (if you can manage it) check your credit score to know exactly where your score falls. You'll need to know this in order to shop for loans, as many lenders do have minimum credit score requirements. There are plenty of ways to check your score for free online.

Your score will fall into one of five categories, according to FICO:

Very poor: below 579
Fair: between 580 and 669
Good: between 670 and 739
Very good: between 740 and 799
Exceptional: above 800

If you have the time, you might want to consider putting off your purchase to raise your credit score. To start, check your credit report for errors, dispute any errors you find, and pay off other debt from loans and credit cards.

3. Figure out how much you can afford to spend each month on your car payment

Find a budget that works for you each month. Look back at what you've spent over the past few months and list out all of your monthly recurring expenses, including debt repayment, housing costs, and other bills and expenses. Then, set an amount for how much you'd like to save for other goals, like retirement or a down payment. Subtract your total amount of expenses and savings from your income, and you'll have an idea of what you have left over each month. Then, find a car you can afford with the money you have available.

Remember that if you have bad credit, you will likely have a higher monthly payment thanks to interest. The average interest rate for a used car buyer with subprime credit, or scores between 501 and 600, was 16.89% in the third quarter of 2019, according to Experian. The less you need to borrow, the less you'll have to pay in interest, so finding an affordable vehicle is a good way to keep expenses down.

4. If you have to, find someone to co-sign for you

If you're looking to buy a car with poor credit or a thin credit file, you've probably considered adding a co-signer. A co-signer is someone who is also listed on the loan, and will be held responsible for making payments if you stop paying. Generally, people ask relatives or parents to co-sign.

Having a co-signer could dramatically reduce the amount you'll have to pay in interest, and make it easier to get approved. But, it's a big risk to the other person: Any missed payments will also impact their credit, and taking on this loan could affect the co-signer's ability to qualify for other credit.

However, it is possible to eventually remove a co-signer through refinancing once you've improved your credit score.

5. Shop around for loans

You'll want to shop around for your loan, and look for the loan with the lowest interest rate and the best monthly payment for your budget. Once you start applying for auto loans, you'll have two weeks to apply to as many as you'd like and have them all show up as one inquiry on your credit report.

To get started with you auto loan shopping, consider these options:

Local credit unions: Credit unions are member-owned banking intuitions, and typically, offer lower interest rates on loans. They often have membership requirements, such as a job at a certain company or residence in a certain area.
Banks you already have a relationship with: If you have savings or checking accounts at a bank that offers loans, it might be worth checking with them.
Online lenders: There are lots of online lenders to try if you're searching for an auto loan, and you might find that they offer some competitive rates.

6. Explore dealer financing as a last resort

If you have poor credit, it might be worth avoiding "buy here, pay here" dealerships. While the allure of guaranteed financing might sound nice, the reality is that high interest rates often mean high default rates.

According to data collected by the National Independent Auto Dealers Association, more than a third of these loans (35.5%) ended in default in 2018, further damaging credit. Make this a last resort.

7. Pick a loan you were approved for, and accept the offer

Once you've found a loan you're happy with, accept that offer. Generally, the bank will either send you a blank check to fill out once you've settled on a deal, or will arrange the financing with the dealership directly. Then, you'll get your car.

8. Make the payments on time, and use this as an opportunity to raise your score

It's important to see this car loan as an opportunity: It's giving you a valuable chance to raise your credit score by making your payments in full and on time.

Setting up automatic payments, where you authorize your lender to take a monthly payment from your bank account, could be a good way to do this. Then, there's no chance you'll forget to make a payment. Additionally, some lenders will offer discounts for setting up auto-pay.

As you build your payment history and your credit score starts to rise, it should be easier to refinance your auto loan or get other credit in the future.

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