Bad credit can stand in the way of many things, including a car loan. But, bad credit doesn't put you out of the running so much as it changes the game.
Bad Credit and You
If you have a bad credit score, it's a score lower than 670 on the FICO credit scoring model. FICO scores range from 300 to 850. The higher your score, the better. Your credit score isn't just an arbitrary number, though. It's what you get when you add together the sum of parts that make up your score. These parts are payment history, 35%; amounts owed, 30%; length of credit history, 15%; credit mix, 10% and new credit 10%.
As you can see, payment history has the largest impact on your score, which means that a lower credit score can be a red flag for lenders about how you've repaid loans in the past.
Bad Credit Impacts on Auto Loans
Bad credit often means needing more proof that you can repay a loan than a good credit borrower may have to provide. This isn't done as a roadblock for you, so much as help, so the lender can see your true situation. Lender's don't want you to default on your loan, that's no good for anyone involved – you lose a car and damage your credit, the lender and dealer lose their profit.
To ensure that a bad credit borrower can handle a car loan, subprime lenders often require:
More documentation: Borrowers with credit scores around 670 or lower may find themselves needing a special financing dealer with subprime auto lenders that require proof of income, employment, residency, and a working phone in your name; they also typically require five to eight personal references.
Longer loan terms: The quicker you pay off a loan the less you pay in interest charges. However, getting those short loan terms means paying more each month, and that may not be an option when you're struggling with credit issues. Many lenders don't offer short-term – 12-, 24-, or 36-month – loans to borrowers with lower credit scores.
A higher interest rate: Your credit score is the biggest factor in determining your interest rate, and the lower your score the higher your rate tends to be. Your interest rate is your cost to borrow money, so the higher your rate the more you repay.
A Cosigner or Co-borrower: In some cases, a lender may offer you a loan as long as you get a cosigner or co-borrower. Though these sound similar they play very different roles in an auto loan. A cosigner lends you their good credit score to help you qualify for a loan if yours isn't quite up to par. A co-borrower, however, lends you a hand when it comes to finances, combining your finances to qualify for a loan. Co-borrowers can only be a spouse or life partner since you can't combine your income with just anyone!
Fewer Car Options: Often the cost of a brand new car is prohibitive for a bad credit borrower, which means they're left to choose from a selection of used vehicles. These days cars are lasting longer and need less service than they did just a few years ago, so you still get to choose from affordable reliable vehicles, many that may have just come off-lease or a short-term loan. Additionally, when you're shopping for a vehicle as a bad credit borrower, you don't get to choose your car first. You must get financing first, then choose a vehicle that falls within your approved loan amount.
Down Payment Requirement: when you have poor credit it's a standard practice that lenders require a down payment. Typically, they require at least $1,000 or 10% of your vehicle's selling price, often whichever is less. However, down payment requirements vary by lender and your situation.
Debt to income requirements: Debt to income (DTI) is a ratio used by lenders to determine how much of an auto loan you can take on. It measures your monthly pre-tax income against your monthly payment obligations for loans, leases, and lines of credit. To find it, add up your payments including an estimated car loan payment. Divide by your gross monthly income. Your answer is how much of your income is already being used. For example, if your monthly payments equal $1,200 and your pretax income is $2,771 you're using around 43% of your income already. Most lenders don't allow bad credit borrowers to take on debt they can't comfortably afford, capping your DTI at 45% to 50% of your income.
Repairing Your Poor Credit
Bad credit can impact your car loan chances, but once you get one through a subprime lender, a bad credit auto loan can be one of the best ways to improve your credit score. A car loan hits many different metrics which raise your scores such as payment history, new credit, and credit mix. Of course, you have to make all your payments on time and in full, and don't let your other bills slip, either, if you hope to raise your credit score.
A car loan is a great way to improve your credit, but it's just one way. You can also become an authorized user on someone's credit card, clean up your credit reports, and pay off outstanding debt, too. Additionally, you can make your current payments work for you by using a service like Experian Boost to get credit for things you already pay.
Ready To Get Started?
If you're ready to find your next auto loan, we want to help. At Auto Credit Express we've worked hard to gather a nationwide network of special finance dealerships that are signed up with the lenders you need. To get connected to one today by filling out our auto loan request form, it's fast, free, and no-obligation.