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.

So, it’s worth shopping around before applying for a loan to ensure you’re getting the best deal on financing.

What a bad credit auto loan is

A bad credit auto loan works just like any other auto loan. The loan is repaid in equal monthly installments over a set term. And the vehicle is yours to keep once it’s paid in full.

Bad-credit car loans typically go to borrowers with credit scores of 580 or lower, which is FICO’s definition of bad credit. Keep in mind that some lenders have their own bad credit threshold.

You can expect higher interest annual percentage rates (APRs) because lenders see lower credit scores as a sign of more risk.

When you apply, bad credit lenders consider your credit score, income and current debt load alongside 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.

Types of lenders that offer car loans for bad credit

There are three main types of lenders offering 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: You can get prequalified for financing in minutes with no credit score impact with most online lenders. 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. The major downside is you’ll likely face higher rates.

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

A low credit score may reduce the amount you can borrow. Because lenders see borrowers with lower credit scores as riskier, they are often less likely to approve larger loans. Saving up for a sizeable down payment can both help fill the financing gap and make you look like a more appealing customer 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.

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. Here are other tips to help you get a bad credit auto loan 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 14.78 percent. Those with a credit score between 600 and 660 averaged 9.60 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. Many such lots advertise they’ll lend you funds without even running a credit check.

But these lots aren’t always the best choice. These 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. Also, shop around to find the best deal on an auto loan that best suits your needs.