If you have good credit, bad credit, or no credit, you should approach the car shopping process with as much strategy as possible. Just winging a large purchase like a vehicle could mean paying more than you need to. We’ve got five steps to make it easier to navigate the car-buying waters.
Seek Pre-Approval For a Loan
From what we can tell, there seems to be a great deal of deception when it comes to the topic of car loan shopping for car buyers with poor credit. Here is something we read not that long ago on another auto loan website:
"Regardless of your credit history, you can get approved for a low-interest auto loan…. Comparing lenders will help you find the best rates."
Whoever wrote this has either never done poor credit auto finance or, if they have, they're trying to convince people to believe in something that isn't true – probably in order to get their credit information.
Here are the facts:
- There is no way anyone with low FICO scores will get approved by any lender for a low-interest auto loan.
- If your credit report is really bad, such as a history of multiple repossessions, there's a good chance you won't get approved for any kind of auto loan – certainly not without a hefty down payment – and possibly not even then.
- Comparing high-risk car lenders can be very difficult. Most of these companies only lend indirectly through franchised new car dealers. This means that consumers won't know the interest rate they qualify for until they visit a dealer that's signed up with one or more of these lenders. Even then, the lender (provided there is more than one approval) is typically chosen based on the overall terms of the credit decision (down payment, loan term, dealer acquisition fee, and interest rate tier), not necessarily on interest rate alone.
When it comes to getting pre-approved for an auto loan, you need to shop car loans with several institutions, like banks and credit unions to see who can give you the best rates. If you're struggling with bad credit preapproval isn't always in the cards though. If you're having trouble getting approved through a direct lender, you need to set your sights on a subprime loan from a special finance dealership.
Documents You Need for an Auto Loan
When you’re preparing for your next vehicle, it can be an exciting time! But, it can also lead to some stress if you’re not sure where to start.
One of the first steps to get ready for an auto loan is preparing your documents. Lenders are largely concerned with your ability to repay the car loan, so you need proof of income.
This typically means bringing your computer-generated check stubs that show your minimum monthly and year-to-date income. If you’re a contractor or freelancer (or earn another source of income that isn’t W-2), then be prepared to bring copies of the last two or three years of your tax returns.
Other common items lenders may ask you to bring in are:
- Recent utility bill in your name to prove your residence
- Cell phone bill that proves you have a working contract landline or cell phone
- List of five to eight personal references with complete contact information
- Possibly a down payment, depending on the vehicle price and your credit score
Once you have your documents gathered and ready to go, you can head to a lender or dealership with confidence, and with as few trips as possible. However, if you have a unique credit situation, such as bankruptcy, the lender may ask for more documents. A quick call to a lender or dealer could let you know what they tend to ask borrowers to bring for the auto loan application.
For a down payment requirement, which many borrowers wonder about, whether or not you need one usually depends on the selling price of the car you’re looking to buy and your credit score. As a general rule, if you’re purchasing a used vehicle, it’s a good idea to aim for 10% down. For new cars, the old adage is to have 20% down to combat negative equity risks, but that’s becoming increasingly harder to do these days due to the rising prices of new vehicles.
If your credit score is poor, expect a lender to ask for a down payment. Bad credit auto lenders generally ask their borrowers to have at least $1,000 or 10% of the vehicle’s selling price.
Budgeting for a Car Loan
If you know that your credit score needs work, you can start saving for a down payment and taking a look at your monthly expenses. Take time to figure out how much disposable income you have available each month that can cover the car payment and the cost of auto insurance. In fact, lenders do this to determine your ability to take on a car loan.
To get an idea of how much you can afford, you can use the debt-to-income (DTI) ratio. Simply add together all of your current monthly bills, excluding utilities, and divide them by your minimum monthly gross income. You should also factor in a vehicle payment that you want to aim for, and $100 for auto insurance (this is what lenders use as an estimate when they determine your DTI ratio).
Here's a quick example:
- Gross monthly income: $2,500
- Monthly obligations: $800
- Estimated car and insurance payment added together: $350
- Debt to income ratio: $1,150 / $2,500 = 0.46, or a 46% DTI ratio
In the example, this imaginary borrower has a DTI ratio of 46%, which just makes the cutoff for most bad credit auto lenders. If more than half of your monthly income needs to be used to pay for your regular bills and vehicle expenses, then lenders may turn you away for financing. However, if you’re under the 45% to 50% mark, then you’re usually in the clear!
You can use our auto loan calculator to see how much vehicle you can afford and play around with down payment amounts.
Rate Shopping for the Best Deal
When you’re on the prowl for your next car, you may be tempted to apply with multiple lenders and look for the best deal – and that’s great! It’s actually a smart strategy when you’re looking to finance anything. If you’re worried about hurting your credit score because of multiple credit pulls, don’t be!
The credit bureaus understand that when you apply for new credit a few times in a short window, you’re looking for the best rates. This is called rate shopping. When you apply for the same type of new credit (like an auto loan) a few times within two weeks, only one hard inquiry lowers your credit score.
If you’re not sure what route to take for your next vehicle, then plan out what lenders you want to apply with and do it in a short window. This way, you can get those hard pulls out of the way, decrease the impact on your credit reports, and compare loan terms from different lenders to pick the best one for you.
Choosing the Right Auto Lender
Finding the right lender for your credit situation starts with knowing what your credit score is, and what your credit reports are saying about you.
Your credit reports act as a comprehensive history of how you’ve handled repaying credit, so lenders look at them with a fine-tooth comb. Before you head out and apply, review your own credit reports and see where you stand. You can request your credit reports for free from www.annualcreditreport.com.
For borrowers with good credit scores, they tend to have more lending options. This can mean heading to a direct lender from a bank or credit union or possibly checking out the captive lenders of automakers. Direct and captive car lenders usually have high credit score requirements.
If your credit score isn’t so hot, then you may need to look into subprime lenders for a higher chance of getting an auto loan approval. Subprime lenders work with borrowers who have credit issues or unique credit situations, and they’re signed up with special finance dealerships. To apply with a subprime lender, you find a special finance dealer and the finance manager sends your application to one or more subprime lenders to see if you qualify.
Finding the Right Car Dealership
A big decision in the car buying process is choosing where you want to buy your next vehicle. For borrowers that can go through direct auto lenders, you can usually take a preapproval anywhere and shop like a cash buyer.
For borrowers who need special financing, you have to find a dealership that’s signed up with subprime lenders.
Finding a special finance dealer isn’t always easy, since they can be hard to pick out from the crowd. However, here at Auto Credit Express, we’ve made that process easier by connecting bad credit borrowers to dealerships in their area with bad credit lending resources.
To get matched to a dealer that can work with your credit situation, fill out our free car loan request form. It’s completely online, and secure, and there’s never an obligation to buy anything. Start the search for your next vehicle today!