Picking out the right car and finding the right lender for your situation shouldn’t be the only things to consider when you’re financing your next vehicle. While both are very important, you should pay for your auto loan in the smartest way possible, especially when you have less than perfect credit.
Don’t Be a Car Payment Shopper
Being a car payment shopper means that you’re most concerned with getting the best monthly loan payment you can. When you focus too much on your payment, it can be easy to get tunnel vision and ignore other parts of your auto loan, like the overall cost.
You can definitely pick out the right vehicle for you, but don’t just focus on getting the lowest car payment you can. Be flexible, and don't focus on only paying the least you can each month while neglecting the rest of your loan terms.
When you have bad credit, focusing too much on monthly payment alone could lead to paying more for the vehicle than it’s worth, and pose other risks to you as well.
Have a Short Auto Loan Term
If you’re considering choosing the longest loan term you can just to get the car payment you want, it’s going to cost you – literally. Auto loans are usually simple interest loans, meaning you’re charged interest daily on the balance of your loan.
Interest is the cost of borrowing money, and the quicker you pay off your loan, the less you pay for the vehicle overall. So, you should aim to owe for the least amount of time you can!
To demonstrate how much of an impact a long loan term can have on your wallet, check out these two examples:
- You finance a car for $15,000 for 84 months with an interest rate of 12%. Over the course of the loan term, you’d end up paying $7,242 in interest charges.
- You finance a car for $15,000 for 60 months with an interest rate of 12%. Over the course of the loan term, you’d end up paying $5,020 in interest charges.
The difference between these two examples is two things:
- Example 1: Monthly payment is $264.79 and the interest charges are over $7,200.
- Example 2: Monthly payment is $333.67 and the interest charges are over $5,000.
While extending your loan term to 84 months saves you $68.88 a month, it costs you over $2,200 more over the course of your loan. With the longer loan term, you have a vehicle payment for two more years.
Remember that when you finance a car, there are other costs involved that can add up, too. It's required that you have full coverage auto insurance, plus you have to factor in maintenance, which can get more expensive as vehicles get older.
Put Money Down on the Car!
If you have a tight budget and you want a more expensive car with a lower monthly payment, put money down on the vehicle. A down payment lowers your monthly car payment, lowers your interest charges (since you’re financing less), and you have less risk of paying more for the vehicle than it's worth.
For bad credit borrowers, paying a lot in interest is often a common concern. This is because borrowers with less than perfect credit don’t usually qualify for lower interest rates. This also plays into the risk of negative equity, which happens when you owe more on the car than it's worth.
If you choose a long loan term with a high interest rate, it could take you a while to pay off the vehicle since the interest charges continue to stack up. This can lead to the car’s value dropping faster than you can pay it off. Negative equity is common, but for a bad credit borrower, it can mean paying tons of cash over the vehicle’s value if you take too long to pay it off.
Put down as much as you can on your next auto loan. You can use cash or trade in your old or current car to help lower the amount you need to finance. Additionally, down payments are typically required for bad credit borrowers. The quicker you start saving, the more you can save later on your next vehicle.
Know Your Car Loan Budget
You should do everything you can to negotiate for the lowest monthly payment you can get, but it shouldn't be the only thing you focus on. Knowing your monthly budget is still important to the overall car shopping process. But don't fall into the payment shopper trap.
In fact, dealers may first ask you, “What kind of monthly payment are you looking for?” This means that you're led to look at vehicles, then the finance manager can tweak an auto loan that gets you the monthly payment you want, but it’s usually done by extending your loan term.
Be an informed shopper and walk into a lender’s office or dealership knowing how much of a car you can afford. This means having a set cap on the vehicle’s selling price that you’re willing to pay, with a shorter loan term, so that you can comfortably afford your payment each month.
You can start budgeting yourself, right from home, by calculating your debt to income (DTI) ratio. This calculation is used by auto lenders, and it can be useful in determining how much available income you have left after all your other bills get paid.
The DTI ratio calculation is easy. Add up all your monthly recurring expenses including an estimated car loan and auto insurance payment, and then divide that total by your gross monthly income. Here’s an example:
- $1,200 (monthly expenses + car expenses) divided by $2,800 (monthly gross income) = 0.428
- DTI ratio of 42.8%.
In this example, 42.8% of your monthly pre-tax income is being used to pay for recurring bills, including a car payment and an insurance payment. Generally, auto lenders require borrowers with DTI ratios less than 45% to 50%. Once you do the calculation yourself, you can then start to play around with monthly payment amounts that you can afford and keep your DTI ratio low so you can avoid overextending yourself.
You can use our auto loan calculator to estimate how much of a down payment you need to get a certain vehicle’s monthly payment to what you want. If you have a lower credit score, you can also research what the average interest rate other people with similar credit scores get assigned for car loans, so you can plan for that, too.
Ready to Move on to Car Shopping?
A prepared borrower is a smart borrower – it’s half the battle of getting ready for your next auto loan. However, when you have credit issues, it can be hard to find a lender that can work with unique credit situations. We want to help with that!
Here at Auto Credit Express, we have a network of dealers that spans the whole country. We know which dealerships are signed up with bad credit car lenders, and we can look for one in your area at no cost. Get started now by filling out our free auto loan request form.