“Subprime” doesn’t have to be a dirty word when it comes to taking out a car loan to buy a new or used car.
In a perfect world, everyone benefits from low interest rates on car loans. But for a large swath of the population, that’s not an option. Blame it on the effects on your finances of the Great Recession of 2008 or missteps in managing your money. Either way, a subprime credit score is not unusual.
“About 20 percent of all auto loans currently are subprime or deep subprime,” says Rick Finch, vice president and general manager at LendingTree Auto Division. “Subprime loans are growing, and auto is the fastest segment.”
Typically, you’re considered a subprime borrower if you have a credit score of 619 or lower, Finch says. That doesn’t preclude you from purchasing a car, but it will cost more because you’re a greater risk in the eyes of the lender.
While everyone has considerations to take into account when buying a car, subprime borrowers have to know a little more. From understanding the ultimate cost of the vehicle to knowing your ability to meet your payments, here’s a look at five things to ponder before taking out a subprime car loan.
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What’s the total cost of ownership?
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Many car buyers go to the dealer with a monthly payment in mind and give little thought to what the ultimate cost of the car will be. As a result, the car buyer gets his or her $300-a-month payment, but that could mean a five-year loan may morph into a seven-year one.
“The longer the loan, the more interest you are paying, especially if you are buying a used car,” says Chris Kukla, senior counsel at the Center for Responsible Lending. “Let’s say you buy a 5-year-old car and slap a seven-year loan on that. Assuming your car can hold up 11 to 12 years, you’ll still end up owing money on the car.”
Knowing how much you can afford each month is prudent, but you also must figure out the interest you’ll pay over the life of the car loan and any fees associated with borrowing money to determine if it’s worth it. You don’t want to end up in a situation where the $30,000 car ends up costing you $40,000.
“People get in trouble when they focus more on the monthly payment versus what’s the total cost of ownership, including repairs, insurance and gas,” says Finch of LendingTree Autos.
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What’s in the fine print?
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The phrase “It’s all in the fine print” is particularly true when it comes to subprime car loans. After all, you are a risk and the lender is going to protect itself, usually by charging you more in fees. But the discrepancies between those fees can be great from one dealer to the next, which is why you need to know what you are signing.
“You need to be diligent in reading all the fine print and understanding what types of fees you are going to incur,” says Eric Lyman, vice president of industry insight at ALG, the automobile industry research company. “There are various ways that lenders get compensation for their risk.”
One common fee that lenders charge is a loan origination fee, but what one dealer charges can vary greatly from the next. “One lender’s origination fee might be $500 while another might be $1,500 for the same car,” he says.
Lyman says combing over all the details of a car loan will ensure that you won’t be surprised by any unforeseen costs. What’s more, knowing the fees ahead of time will put you in a better position when you are negotiating the purchase price and auto loan terms.
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Can you make the payments?
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Everyone needs a mode of transportation. But before borrowing money, borrowers with credit problems need to think about the ramifications of not paying back an auto loan. After all, you don’t want to end up in a worse credit situation because you can’t afford your ride.
“When borrowing money, you need to make a realistic assessment of yourself and your capabilities,” says Lawrence White, professor of economics at New York University Stern School of Business. “You need to think longer term rather than, ‘I need this today and will worry about it tomorrow.'”
Industry experts say that while a BMW may be an appealing vehicle for your commute, your credit history and current household finances may make it more prudent to go with a lower-cost sedan.
“Just because it’s a subprime car loan doesn’t mean you shouldn’t do it,” says White. It’s more about how much you need the car, did you get a good price on the car and can you afford to pay back the loan, he says.
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Can you find a lender?
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If you have a credit score over 680, chances are you’ll have auto lenders banging at your door to offer you low-interest car loans. Have a score below that and there may be no one calling.
“If you are a consumer with credit challenges, whether that’s because you don’t have a lot of credit history or missed payments, you have more work to do,” says Kukla of the Center for Responsible Lending. “If you have a score below 680, the number of lenders willing to give you a loan decreases pretty rapidly.”
While prime borrowers can easily get a low-interest auto loan from the bank down the street, Kukla says consumers with bad credit only have a couple of options: They can turn to the Internet or rely on a dealer.
If the dealer route is under consideration, know that it can be costly.
“One of the biggest misconceptions we see out there perpetuated by dealers is that they do business with dozens of lenders,” Kukla says. “Nothing could be farther from the truth. The dealer is looking for the best loan for them, not the consumer.”
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Are you committed to the challenge?
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When it comes to borrowing money when you have bad credit, you have to be able to take rejection. That’s because you are likely to be turned down multiple times before you find a lender who will give you the money. On the other hand, you also don’t want to assume the lender or bank will say no just because you have credit challenges without giving it a try.
Kukla says he hears plenty of stories of consumers who assumed a bank or credit union wouldn’t give them financing only to learn later that they could have gotten it, and gotten it much cheaper, if they had asked.
“Never assume you can’t get credit,” Kukla says. “The worst thing you will hear is the word ‘no.'”