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It’s common for economic hardship to damage credit to the point where getting approved for a car loan might seem more difficult, even though a car is key to meeting needs like going to work, school and, ultimately, getting back on solid financial footing.
While it may seem daunting to qualify for a car loan with a bad credit score (below 580), there is a large network of lenders and car dealers who are more willing to work with low- and bad-credit score borrowers. If all goes well and payments are made on time, it can help boost your credit profile.
We will walk through the process of getting a car loan with bad credit, including how to prepare and how a car loan impacts your credit.
5 Steps to Take Before Applying For a Car Loan
It’s easy to feel the urgent need to get a car as soon as possible when it can be the key to getting a job faster and improving your credit score in the long run. But it’s important to be patient and do your research first by assessing your own financial situation as well as options for loans and vehicles.
Here are five steps to take before applying for a car loan.
1. Check Your Credit Score
Auto lenders who accept an applicant with a low or no credit score will typically charge a higher interest rate or have more costly loan terms in order to cover the risk of lending you money.
Your credit score is a summary of your credit history and creditworthiness that lenders use to determine where to approve you for a loan and what terms.
It’s crucial to check your credit score and credit history ahead of time and fix any errors, or try to catch up on late payments to improve your score and lower the cost of your loan.
Most lenders will grade your FICO score, a three-digit number typically ranging from 300 to 850, the following ways:
• Exceptional: 800-850
• Very Good: 740-799
• Good: 670-739
• Fair: 580-669
• Very Poor: 300-579
If you have a fair or very poor credit score, you should aim to fix your credit profile by removing any errors and paying all your bills on time
Your payment history makes up 35% of your credit score and is the most important factor. Other factors that make up your credit score include credit utilization (30%), length of credit history (15%), new credit (10%) and credit mix (10%).
You can check your credit report with each of the three bureaus through AnnualCreditReport.com. You can typically check your report for free once per year, but due to Covid-19, each credit bureau is offering free weekly credit reports until April 20, 2022.
2. Assess Your Income and Debt
Even if you have a low credit score, lenders will also look at your monthly income against your monthly expenses to weigh your ability to repay a loan. They want to see that you can make the new monthly car payments in addition to your existing debt obligations.
This will help the lender determine whether to issue the loan and how much interest, additional fees or down payment might be required to secure the loan. The higher the risk, the more you will pay in loan fees.
So before you apply for a loan or go car shopping, total your monthly debt against how much income you receive to get a better idea of how much you really can afford to pay per month.
3. Prove Personal Stability
In addition to income and debt information, lenders also look at how long you’ve been with your current employer and lived at your current address. This signals to them that you are secure in your job and settled where you live.
Employment and residency are two factors lenders use to measure the risk you pose as a borrower. You may need to show the lender proof of address and several recent paycheck stubs.
4. Consider a Down Payment is Key
It might be difficult to have extra cash on hand when you’re trying to pay bills to improve your score, but even having a few hundred dollars to put down for a car can help the lender approve you for financing and lower the upfront costs.
The ability to put a down payment—an upfront partial payment—on a vehicle signals to the dealer or seller that you are serious. Depending on how much you can put down, it can help reduce the overall size of the loan, upfront taxes and fees, your monthly payment, the length of the loan and/or the interest rate.
5. Know How Much You Can Afford
An auto dealer’s job is to upsell you on a car, so before you begin looking, it’s critical that you assess how much car you can afford. You, better than anybody, should know how much debt you can afford on a monthly basis based on how much you spend per month against your income.
Beyond this, start doing online research about how much you’re likely to pay for car insurance, registration fees, parking, gas, property taxes and other expenses that are tied to owning a vehicle beyond the loan.
Buying a vehicle is an emotional experience. Don’t get caught up in either the hype of the purchase or the intimidation of sitting in a sales manager’s office. Write the number you’re comfortable with spending on a car and stick to it. The last thing you want to do is finance a car you can’t afford and damage your credit score further.
How to Shop for Car Loans With Bad Credit
Even though you may have bad credit, there is an abundance of lending sources for you to choose from. Part of that is because the vehicle acts as collateral and secures the loan, which helps reduce the risk the lender takes on. However, if you repeatedly fail to make on-time monthly car payments or default, the lender can repossess the car.
Here are three ways to start looking for a car loan.
1. Shop Online
There are thousands of traditional banks, credit unions and nonbank online lenders that give a range of their auto loan interest rates on their websites. If you have a low credit score, you will pay on the higher end of the interest rate and fees they post online.
2. Go To Your Bank
If you already have a relationship with a bank or credit union, it might have a lower rate or special deal because it will want to keep or expand their services with you. Your financial institution can often assess your information easier or faster if your bank trương mục is already with them.
Before you formally apply for a car loan, check your financial institution’s website or call them and ask for a rough estimate of what you might pay monthly for a car loan based on your credit score, income and expenses. Knowing the type of car (new or used) and max price you’re willing to spend will also help narrow down a quote personalized to you.
You can also seek preapproval, which means it will run a credit check (with a soft credit inquiry only) and tell you how much it’s willing to lend, and at what interest rate. This can be a powerful tool to take with you into a dealership to negotiate for a lower car price or better loan terms.
3. Getting a Loan at the Dealership
Most dealerships will gladly offer financing on-site in order to sell a car faster, but some are more reputable than others. Dealers typically partner with banks and other lenders to do this. Be sure to read the fine print because some dealers will bury fees and offer expensive loans, especially if you have bad credit.
This is why it’s critical to first shop around online and seek options with your own bank to make sure you get the best deal. Sometimes, the rate is lower at your existing financial institution while other times it might be lower at the dealer, depending on the added fees.
Getting Approved for a Car Loan
Most dealerships and auto lenders can tell you fairly quickly whether or not you’ll qualify for a loan, especially if you’ve already prepared your financial information before walking onto the car lot.
Still, going into a dealership with a preapproved letter from your bank or credit union is among the best strategies for buying a car with bad credit.
If you can’t get preapproval or need financing at the dealership, carefully look over the terms, conditions and fees before signing the loan. Not every auto lender through a dealership is fully regulated by the federal government like a traditional bank or credit union, so take your time to look over the terms.
And don’t be afraid to walk away if the terms seem too costly or feel like a “gotcha” moment. There is often another auto dealer or lender nearby that will also work with bad credit.
Bring a Co-signer
If you are worried about a rejection due to bad credit and lack of a down payment, you can also add a co-signer to help secure the loan.
Bringing a friend or relative to a car dealership or bank to act as a co-signer is one of the most powerful tools you can have for getting a loan with bad credit and lowering the overall cost of the loan, such as a lower interest rate.
How a Car Loan Impacts Your Credit
A car loan can be either good or bad for your overall credit. Handled right, it helps you establish a positive credit history through on-time payments and improves your credit mix on your credit report. However, if you miss payments or default, a car loan can damage your credit.
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Don’t Be Afraid to Walk Away
Buying a car is often a very high-pressure sale that can impact your credit score significantly, either in a good way or bad. That’s why it is so important to do your homework and take your time, regardless of how much you want a car.
If you like a vehicle that costs more than what you can afford, don’t accept a longer loan term to achieve cheaper monthly payments. If you accept longer terms on a car loan, you will pay more in interest over the life of the loan and may pay more for the car than it’s actually worth over time.
Cars do not appreciate in value like houses. It’s often said they depreciate the moment you drive it off the lot. Keep in mind that if you do get a longer term loan and are forced to sell the car before you have finished paying off that loan, you still have to pay back the balance on the loan.
Your best bet is to walk away from a car you know you can’t afford and find a comparable vehicle that costs less.