Buying a Car with Bad Credit: What to Expect and What to Avoid

Even as July numbers show the auto industry is on track for near-record sales volume of 17.5 million vehicles this year, according to Kelley Blue Book, the fact of the matter is that fewer people than ever before are actually buying new cars, SUVs and trucks—at least when it comes to outright purchases where financing isn’t involved.

According to the most recent Experian “State of the Finance Market” report, the proportion of customers who financed new vehicles climbed to 84.9 percent in the first quarter of 2015, with a record 55.6 percent of used-vehicle purchases being financed at that time. And it’s not just “well-qualified” customers who are driving that increase: There also are plenty of opportunities for vehicle financing for drivers with less-than-perfect credit. Just remember, that doesn’t mean those are necessarily good opportunities.

Greg McBride, chief financial analyst for Bankrate.com, says, “Most Americans have good enough credit for auto financing, so everyone who has a pulse can get approved right now. But while recognizing vehicle ownership can sometimes be an absolute necessity, many people in bad debt situations got there from taking on big loans, and those with credit scores below 620, where options really thin out, are frankly better off not buying.”

Those with poor credit also may have to have a cosigner to qualify for a car loan, and that brings issues of its own. Melinda Zabritski, senior director of Automotive Finance for Experian, notes, “A cosigned loan will appear on both the primary borrower’s and the cosigner’s credit reports. Late payments and default will appear on both. Be very cautious about cosigning. If the person you cosign for does not pay the debt, they will damage your credit report and scores, too.”

That’s why one of the very first things shoppers should do as part of the vehicle-purchasing process is check their credit scores. Justin Leach, manager of Public Relations for Toyota/Lexus Financial Services, recommends, “Several months before you think you’re going to be financing a car, get a copy of your credit report from all the major credit reporting agencies and go through each one and make sure all the credit history and personal information is up to date. If not, it doesn’t cost anything to dispute errors. Once you file a dispute, the bureau and your creditor must investigate it and correct or remove any information that isn’t accurate. You may have some blemishes on your report, but don’t let errors make it worse.”

After you have an up-to-date credit report in hand, then you can start looking at financing, and consumers are advised to put a significant effort into comparing terms. According to Chris Kukla, senior vice president for the Center for Responsible Lending, “Consumers with blemished credit especially need to shop around for financing before going to a dealership. We would suggest that consumers start with a bank or credit union with whom they normally do business, and check with other lenders as well. Consumers should also shop between dealers. A consumer who has shopped around will have a general idea if an offered rate is fair.”

Be careful as you compare finance offers, too, as Kukla additionally warns, “Consumers with poor or no credit history are disproportionately targeted for ‘yo-yo’ scams: Dealers are the initial creditor in car financing, and sell those contracts to other lenders. They routinely allow a consumer to drive a car off the lot before their financing is finalized, but assert the right to unwind the deal if they don’t like the terms they get with the ultimate lender.

Dealers then call the consumer back to sign a new loan with a higher interest rate or other changes. In some cases, dealers will refuse to return the consumer’s trade-in vehicle or down payment, or will tack on daily-use charges that can total hundreds, if not thousands of dollars.”

Beyond that kind of worst-case scenario, Experian’s Zabritski points out, “This is a highly regulated industry, especially in the lower-credit segment, and customers really want to take advantage of what can be offered by dealers, who have numerous relationships with lenders here.”

Kukla’s advice is to check with the U.S. government’s Consumer Financial Protection Bureau, as well as a given state’s attorney general’s office, for complaints about auto loan lenders before signing.

That’s because car loans are an increasingly steep financial commitment for owners. Keeping in mind that rates are always fluctuating, Experian data from the first quarter of 2015 shows that the average interest rate for a new-vehicle loan was 4.71 percent and the average credit score for new-vehicle customers was 713. Rates for used vehicles were even higher, with the average interest rate at 9.17 percent in the first quarter. But Zabritski further indicates that for customers in what she calls the “deep subprime” range, with credit scores below 501, new-vehicle loan rates are at about 16 percent.

Since the average loan terms are now extending to 67 months on a new vehicle, according to Experian Automotive, and the average amount financed coming in at $28,711 for a new car, the difference for customers is striking. The shopper who qualifies for an “average” loan term would face 67 payments of $488.17 each and a total expense of $32,707.39; for a deep subprime customer, monthly payments jump to $650.72, with total loan costs rising more than 33 percent to $43,598.24.

If you find yourself in a situation where you’re struggling to pay your car loan, Toyota’s Leach says, “The important thing to remember is that if you think you’re going to be late paying bills, talk to your creditors. Too often I’ve heard people say ‘I didn’t want to tell them I couldn’t make a payment because I was embarrassed,’ or ‘I was afraid they would try harder to collect.’ The truth is, if you contact a creditor before you’re late on a payment, they may have more opportunities to help you, such as offering a deferred payment or rescheduling your payment due date.”

If you’re in the market for a car and you have bad credit, be sure to carefully shop for the right lender first, and only do that after verifying that your credit report is correct. Consumers with less-than-prime credit scores still can expect higher interest rates, along with higher total loan costs, but that financing can be a major milestone on the road back to better financial health.

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