Car Finance

Car Financing on Bad Credit: What You Need to Know

By Mike Richards Updated: 04/12/2018 Posted: 04/02/2018

There are a number of pitfalls you will need to avoid when looking for a car loan facility on bad credit. Before you go shopping for a car loan, you better be absolutely sure that getting car financing is the best way to go. For instance, you could decide to just stay put until your credit score improves or just look for other softer funding options.

However, if in spite of a bad credit score (a FICO score of below 600 is considered bad or poor) you still feel you have no option but to get a car loan, there are a number of things you need to be aware of.

1. Carefully Compare Lenders, Interest Rates, Penalties, And Fees

Every lender has advantages and disadvantages. Some will charge very high origination fees while others won’t. Others will penalize prepayment and late payments while others won’t. Interest rates also vary from lender to lender, and even within the same lender. For instance, a person with a good credit score will attract a lower interest rate from the same lender than one with a bad credit score. Before you settle on a particular lender, you should carefully analyze the entire cost of taking a car loan. But don’t rely on just one lender, get quotes from at least two lenders before settling on one.

2. You Will Likely Attract Very High Interest Rates

Most lenders are averse to bad credit scores. Those who may decide to take a chance on you understand that you are a high-risk candidate. The impact of this is that you set out at a disadvantage since such a lender will most likely charge you high-interest rates to make up for the poor credit rating. This should not, however, deter you from applying for an auto loan if that’s the only option available to you.

3. Be Wary of “We Finance Everyone” Lenders

Just because you are desperate does not mean you should put yourself at the mercy of unscrupulous lenders, especially those that purport to offer loans to everyone; even those with bad credit scores. Most credible lenders shun high-risk borrowers, especially those with a poor credit history. If a lender tells you that they don’t mind your bad credit score, this could be a bad sign. You may get the loan, but the interest rates, fees, and penalties will most likely be extremely high.

4. Your Credit Score May Take A Beating

As mentioned above, getting quotes from a number of lenders could actually get you into deeper trouble. Every time a borrower approaches a lender for a quote, a hard credit pull or inquiry is conducted on him or her. This could potentially lower your credit score by a few points. When done by a number of lenders, the few negative points from each could add up to substantial damage to your credit score.

The negative impact of a hard credit inquiry may remain on your credit reports for about 24 months, making it even more difficult for you to secure loans in the future. Besides, a worsened credit score attracts even higher interest rates. Soft credit inquiries, however, do not hurt your credit score.

A credit score is a 3-digit number calculated on the basis of your credit report and normally ranges between 300-850 points. It is largely used by lenders to establish your creditworthiness. As a general rule, bad or poor credit refers to a FICO score of below 600 points.

To keep your credit score above the green line (over 600 points), you will need to understand what can affect it negatively.

Your credit score can be affected by your payment history. Late payments and defaults could adversely affect your credit score. In fact, close to 35% of your score is largely informed by your payments history. You, therefore, need to keep those payments regular to avoid hurting your credit score.

Your existing debts could also hurt your credit score by as much as 30%. If you are heavily indebted, chances are that your credit score will be hurt. The types of loans you pick up could also inform the strength or weakness of your credit score. Another contributor to your credit score is your credit history, which could account for up to 15% of your credit score.

You will also need to be careful about the number of loans you are picking up. This is because 10% of your credit score is based on new credit applications. When applying for a new loan facility, a hard credit pull may negatively affect this part of your credit score. Lastly, the type of credit you pick up accounts for 10% of your credit score.

Applying for an auto loan while your credit score is bad or poor could adversely affect your credit score as well.

One or a combination of two or more of the above factors could severely affect your creditworthiness and hence jeopardize your chances of getting loans in the future.

5. Consider Leasing, Rather Than Buying A Car

A lot of people nowadays are leasing instead of buying vehicles. Although with a lease you never own the car since you have to return it at the expiry of the lease, the monthly fees are usually lower than the monthly payments towards buying a car. In any case, at the end of the lease, you may decide to buy the car, renew the lease, or get a new one under a fresh lease arrangement.

Another advantage of a leased car is that at the expiry of the lease, you just return the vehicle, pay any outstanding charges and simply walk away. However, if you own the car and you don’t need it anymore, you are stuck with the tedious process of looking for a buyer; this could take a considerable amount of time.

6. Consider Using A Cosigner/Guarantor

A cosigner can bail you out if you have bad credit. A cosigner is someone who legally undertakes to pay up a loan should a borrower fail to do so. A cosigner improves your chances of getting a car loan since the lender is assured that, should you default, the cosigner will act as a guarantor to the loan. You will still be required to pay back the loan, but at least your credit score won’t be as adversely affected as it would be had you applied without a cosigner.

7. Avoid The Temptation To Lie Or Misrepresent Facts

If you lie about your financial situation, the one thing you can be certain of is that you will get caught! So, don’t even try to inflate your income so as to look more creditworthy to the lenders than you actually are. Doing this will only land you in more financial and legal trouble. It’s just not worth it.

8. Accept This Might Not Be The Right Time To Buy A Car

After considering all the options above, you may have to face the hard fact: getting a loan when your credit score is down may not be such a good idea! Besides sinking you deeper into debt, it could expose you to exploitation by unscrupulous lenders. First, the interest rates you will be charged will be too prohibitive. Second, the fees and penalties for prepayment and late payments will be highly punitive. Third, should you default, the likelihood of your loan being ‘sold’ to a third party debt collector is very high? Debt collectors can be a nightmare to deal with. Instead, wait until your credit rating improves before taking the trip to the auto loan lender. You may actually not need the loan after all.

Summary

While getting a car loan may appeal to you, in spite of a poor credit score, you will need to do due diligence to make sure you do not get into deeper trouble than you are currently in. As a general rule, don’t take up more debt if your current credit score is bad. Although a majority of lenders avoid clients with a bad credit score, there are some who will; but one has to be prepared to pay exorbitant fees, penalties and interest rates that may end up surpassing the actual cost of the car.

Comments