When you have less than perfect credit, it can be scary when you need an auto loan. Bad credit leads to things like higher interest rates, and, possibly, less vehicle selection compared to borrowers with good credit. But if you know exactly what you're in for and stick to a budget, bad credit car buying doesn't have to be frightening at all. However, don't forget to budget for the total cost of an auto loan beyond just the sticker price.
Stick to Your Budget
Purchasing a vehicle when you have bad credit means that you have to meet additional requirements than borrowers with good credit. These include income, residence stability, and employment, and lenders look at these to ensure you can comfortably handle adding a car loan to your budget.
One of the things a lender does to determine if you can afford an auto loan is "debt you out." This means they calculate your available income to see if you can add the cost of a vehicle and insurance to your budget. They do this with two calculations: the debt to income (DTI) ratio and the payment to income (PTI) ratio.
You can budget for your loan by doing these calculations yourself:
- Payment to income ratio – A payment to income ratio lets a lender know what a maximum monthly payment is going to be for you. Subprime lenders typically don't accept a car payment that's more than 15 to 20% of your income. To find out your maximum PTI ratio, simply multiply your pre-tax monthly income by 0.15, and then multiply it by 0.20 to give you a maximum payment range. For example: If you make $3,900 a month before taxes, you would be capped at between $585 and $780 a month for an auto loan payment.
- Debt to income ratio – Your debt to income ratio shows a lender how much of your income is already set aside for your bills. Now that you know what your ideal payment range is, you can calculate how much of your income is used by your bills, including your estimated car loan and auto insurance payments. To calculate your DTI ratio, add up all of your monthly bills, including the new car loan and insurance, and divide the total by your pre-tax monthly income. Bad credit lenders typically require a DTI ratio of 45 to 50% or lower in order to approve you for an auto loan.
More than the Sticker Price
Even though the lender may approve you for a monthly car payment as high as 20% of your pre-tax monthly income, a good rule of thumb is to work toward a loan payment that accounts for only 10% of your income. This way, you keep room in your budget for items like insurance, fuel, and maintenance – possibly allowing you to keep your total monthly vehicle budget under 20% of your income.
Besides accounting for monthly car-related expenses, you should remember that your budget should account for other expenses including tax, title, and license (TTL) fees, dealer fees, and a down payment. All of these things can increase the cost of your loan, and may be required upfront:
- Tax, title, and license fees – Tax, title, and license fees are required, and vary by state. Though it's possible to roll these fees into your loan, we recommend that you pay them upfront to save a bit of money in the long run. Every cost added to your total loan balance, no matter how small, incurs interest charges. Because borrowers with poor credit already pay higher interest rates, it's a good idea to keep your loan as small as possible.
- Dealer fees – Dealer fees, such as document fees or filing fees, are often added to the cost of your loan. The costs of these fees vary by dealership and by state, and are negotiable. Some states cap how much a dealer is allowed to charge, while others don't – so it's not uncommon to find dealer fees in the hundreds of dollars. Don't be afraid to call out a dealership if you feel the fees are excessive, or to walk away if they won't budge.
- Down payment – A down payment is almost always required for bad credit car buyers. Most lenders that work with bad credit only require a minimum down payment of $1,000 or 10% of the vehicle's selling price, whichever is less. Though you may feel this isn't ideal for your budget, a down payment is actually a big help in the long run. When you make a down payment, it improves your chances of getting approved and it shows the lender you're willing to invest in your own success with this auto loan. It also decreases the cost of your loan, which in turn lowers the interest charges you pay down the road.
Ready to Find Your Next Car?
If you've budgeted for the total cost of a car loan and are ready to find financing, Auto Credit Express wants to help. We've been connecting bad credit car buyers to special finance dealers that can get them into new and used auto loans for over 20 years.
By simply filling out our no-obligation car loan request form, you gain the power of our nationwide network of special finance dealerships. Rather than driving all over town having dealer after dealer run your credit only to turn you down, we'll work to match you with a local dealership that has the lending resources you're looking for. Don't wait any longer to take your next step toward the auto loan you need!