Car loans for bad credit: What they are and traps to avoid

A bad credit auto loan is a form of car financing that caters to borrowers with lower credit scores. These loans generally come with higher borrowing costs and other pitfalls. This can make them a headache if you don’t dig into the details before accepting.

To be sure you get the best rate, it’s worth shopping around before applying.

What is a bad credit auto loan?

Like other auto loans, auto loans for bad credit are repaid in equal monthly installments over a set term. Once paid in full, the vehicle is yours to keep.

When you apply, bad credit lenders consider your credit score, income and current debt. If you already have a car in mind, a lender may also consider the make, model, age and condition of the vehicle you’re interested in. Based on this information, the lender determines your interest rate and the maximum amount you’re approved to borrow.

However, you can expect higher interest rates. On average, borrowers with bad credit qualify for rates in the double digits — often upwards of 12 percent for a new car and over 18 percent for a used car. This is because lenders see lower credit scores as a sign of more risk.

Types of lenders that offer car loans for bad credit

There are three main types of lenders that offer bad credit loans.

• Banks and credit unions: You can potentially qualify for a loan with reasonable terms if you have a positive relationship with your financial institution. Still, the minimum credit score may be higher compared to online lenders.
• Online lenders: With most online lenders, you can get prequalified for financing in minutes with no impact on your credit scor. But you won’t get in-person support, and you may not be familiar with the lender you’re matched with if using an online comparison platform.
• Dealers: Dealerships offer a one-stop shop for borrowers. You can handle buying and financing in one sitting, and some dealerships can offer loans regardless of your credit score. The major downside is you’ll likely face higher rates.

How much can you borrow with a bad credit auto loan?

A low credit score may reduce the amount you can borrow. For borrowers in the subprime category, the average amount financed on a used car is a little under $22,000, according to data from Experian.

Because lenders see borrowers with lower credit scores as riskier, they are often less likely to approve larger loans. Saving up for a sizable down payment can both help fill the financing gap and make you more appealing to lenders.

If you want a high-end vehicle but can’t get approved for the full amount, try checking out older model years. Buying certified pre-owned can eliminate some of the risks of buying used, but it may be harder to qualify for.

Getting a car with bad credit? Follow these tips

Before starting your search, calculate how much car you can afford and be honest with yourself about your budget. It is unlikely that you will qualify for a new car at a reasonable interest rate, so shop used cars. And most importantly, compare at least three lenders to find the most competitive rate for your financial situation.

Here are other tips to help you get a car loan with poor credit without falling into common traps.

Prepare for a higher interest rate

The best auto loan rates are reserved for borrowers with excellent credit scores. You will face much higher rates if you have a credit score in the 500s. If you can hold off on purchasing a car, you may be better off working on improving your credit to qualify for a lower interest rate.

According to most recent Experian data, those with credit scores between 300 and 500 had an average interest rate of 15.62 percent when purchasing a new car. Those with a credit score between 601 and 660 averaged 9.62 percent.

Be sure to look beyond interest rates when comparing loan quotes from dealerships. Pay attention to added costs, like origination fees and prepayment fees, that some lenders charge on auto loans.

Try to avoid buy-here, pay-here lots

Some dealerships will refuse to sell you a vehicle if you have bad credit. These buyers are buy-here, pay-here lots’ target audience. These dealerships advertise auto loans and car purchases without running a credit check.

But these lots are rarely the best choice. Even for bad credit auto loans, buy-here, pay-here loans often carry high rates, stacked fees and even the requirement to equip your car with a GPS unit for easy repossession. Instead, check out online lenders that cater to bad-credit buyers, such as Caribou or Autopay.

Don’t take the longest term available if you can help it

You’ll get a more affordable monthly payment with a longer term. The tradeoff is steeper borrowing costs over the life of the loan. Some lenders also charge higher rates for an extended repayment period since the risk of default is higher.

It’s worth choosing the shorter term if you can comfortably afford the higher monthly payment.

The bottom line

Be sure to run the numbers before applying for a bad credit auto loan to ensure the benefits outweigh the costs. You may also want to consider leasing a car with bad credit, although it may be more difficult to qualify.

Ultimately, it is possible to borrow an auto loan with bad credit. You will have to do more legwork to find lenders, and you will need to budget for a higher interest rate — but it is possible. Be sure to weigh all options and shop around to find the best deal before you commit.