What Are Adverse Credit Car Loans?
Adverse credit car loans are loans that are extended to individuals whose credit ratings are too weak to get quick online approval. These types of loans are referred to as subprime lending. If you have less than good credit, your financing options in general are considerably limited. However, as long as you are in active employment, there are strategies you can use to successfully get car financing.
Experian defines subprime as a 619 score or below on its Vantage scale. Apparently, the default rate on car loans is far less than other industries, so some lenders are willing to take on certain borrowers with relatively poor credit history. Many experts attribute this to the fact that cars are easier to repossess and resell.
Furthermore, since people need their car to get back and forth to work, people in active employment are less likely to take the risk of losing their main mode of transport. Another influencing factor is the fact that 60 percent of the adult population have less than optimal credit these days, and if lenders are too restrictive in taking on less than ideal borrowers, the industry could stagnate.
Impact of Credit Score
Your credit score is one of the most important factors in your financial life because it determines your credit worthiness. Your credit score – also known as the FICO score – is a single number between 300 and 850 that summarizes your credit history, with 850 being an excellent score and 300 being the worst. It is a powerful indicator of your potential to default on a loan or line of credit. That score is what a lender will base the amount of interest to charge you on a car loan. It also influences your down payment and the maximum amount of money you can borrow to purchase your new car. It’s not that hard to lose a good credit rating either: It can happen if you get into an unresolved dispute, or let a bill go unpaid for more than two months.
A good credit score is generally in the range of 660-749 but may vary from lender to lender. Scores in the 500’s or below are often refused altogether for loans and leases. In any case, the higher the credit score, the lower the interest rate you will receive for a loan or line of credit. This means that having a good credit score can effectively save you thousands of dollars in interest over the life of the loan or line of credit.
Every borrower is assigned a credit score based on their performance with previous loans. In addition to the national credit cards companies like MasterCard and Visa, department store credit cards, gas station credit cards, telephone companies, utility companies, insurance companies, and the like all report your payment behavior to the credit bureaus.
How Credit Score is determined
- Your payment history which accounts for 35% of your credit score
- The amounts owed which accounts for 30% of your credit score
- The length of your credit history which accounts for 15% of your credit score
- New credit which accounts for 10% of your credit score, and
- The types of credit used which accounts for 10% of your credit score.
Your payment history also shows the history of how you paid your bills, either on time or late. By keeping track of your payment history including the timeliness of your payments, whether you carry a balance, pay your account off in full every month, or if in fact you pay at all, reporting agencies assign a numerical value to the level of the perceived risk you represent which is effectively your credit score.
Interest and Down Payment
When you try to finance or lease a car with a “subprime” credit score, you can expect to be asked to pay a higher down payment, higher interest rates, and/or a security deposit (for a lease). The actual interest rates for adverse credit car loans will vary according to credit score, but will typically range from 5 – 26%. The down payment you are required to put down will also depend on your credit score, and can range from 20% to 50%.
Follow the steps below in order to successfully finance the purchase of a used car even if you have bad credit:
Start by optimizing your credit.
To boost your chances of success, it is important to improve your credit score as much as possible before you apply for financing. If you’ve ever had a credit card, car loan, student loan, mortgage or other debt, chances are credit bureaus Equifax, Experian and TransUnion each have their own credit history report on you. The report will detail all past and current credit accounts, mortgages, loans, and/or leases– including missed payments, late payments, bankruptcies, and repossessions.
Start by ordering a copy of your credit report from each of the 3 credit bureaus. We are all entitled to a free credit report once every year from all three of the reporting agencies. When you receive the reports, review them for mistakes, errors or missing information. Make sure that they only contain information that is 100% accurate. Errors in credit reports are very common, and if you dispute any of the items and they can’t be proven, they must be removed from the report. Pay close attention to the section that points out potentially negative items, also called risk factors. Risk factors could be anything from an old debt that went to collection to a fine you had to pay in a civil court case. The risk factors are present in all reports, so if you fix an issue you found on one credit report, the action will be reflected on all the other reports. Fixing risk factors will raise your credit score, sometimes significantly, depending on how many negative items you can have removed.
Next, put together a plan to get your debts in order with those that are past due at the top of the list. Pay off small judgments and get any past-due debts off your credit. Even nominal amounts that are reported as negatives on your credit report can impact your bad credit for the worse. Make a list of your past due debts from smallest to largest because the largest debt hurts your credit just as much as the smallest if they are both past due. Contact each of your creditors directly and arrange a formal payment plan with them that you can stick to. If they know you are dead serious about cleaning up your financial history, they will work with you. Optimizing your credit is not going to happen overnight.
Once you’ve corrected all errors, buy a copy of your FICO credit score. FICO scores normally come with your credit report, but federal law doesn’t require credit bureaus to give you them for free. You’ll need to be prepared to give this process at least six months to allow time for the improvements to take place. This can also help you keep unscrupulous car dealers or loan brokers from putting you into really bad loans.
Plan your budget.
If you don’t currently have a car, your next step is to create a budget to work out exactly what type of car you can afford to buy and whether you can afford the monthly cost of ownership. This is one of the most expensive purchases you will ever make. Keep in mind that you will be paying a large upfront deposit and higher monthly payment due to a higher cost of borrowing. Keeping all of this in mind, can you realistically afford to own a car?
Start by making a list of all of your sources of income. What is your gross household income? This can include your wages, your partner’s wages, any passive income you generate from different sources, etc. Next, make a list of your outgoings. This should include all of your monthly expenditures including what you are spending on rent or a mortgage, credit cards, food, utilities, gym, cable, apps, premium memberships, clothes, leisure, hobbies and interests, etc.
Once you have a clear and accurate figure of how much you are earning and how much you are spending, you need to now factor in the cost of the car you would like to own and determine whether you’ll still be able to live the kind of lifestyle you are accustomed to. The cost of owning a car includes monthly payments, insurance, extended warrantees, maintenance, fuel, taxes, parking, tolls, congestion charges (where applicable), tickets, etc.
Your target monthly payment includes the sales tax, title and registration fees that would be added to your total loan. For example, if you are earning $40K a year and are paying out $1300 on rent or mortgage, you are already maxed out on what lenders call a reasonable debt load. You simply won’t be able to afford the cost of a car without over-extending yourself considerably.
Open a Secured Credit Card
As you are in the process of rebuilding your credit, a secured credit card would be the perfect option for you. A secured credit card is a credit card that requires a cash collateral deposit that becomes the credit line for that account. It works like this: You deposit money into an account ($250 – $500) and the lender generally offers you a line of credit that is equal to the amount you deposited.
You are virtually guaranteed to be approved for the line of credit, as you are putting up 100% of the collateral. In other words, the bank has no risk in approving you. By using a secured credit card strategically, you can use it to build up your credit by making timely payments each month, and demonstrate a good payment history on your credit reports.
This time, maintain regular payments on any credit accounts on time, and in full (draw from the money you’ve set aside, if it’s necessary). Because your payment history accounts for the largest determinant of your FICO score (35%), paying your bills on time is crucially important during this period. Once you have saved up enough money for a down payment, your credit score should also be improved to yield better interest rates.
It is however important to use only banks that will report your payment history to the credit bureaus. You should only establish accounts with banks that plan to report your payment history. Furthermore, you should make sure the cards are secured rather than prepaid. Prepaid cards give you the ability to make credit card purchases, however, the payment activity is not reported to the credit bureaus which means it will have no impact on your credit score no matter how prudent you are with your payments.
Making the application
Once you’ve taken care of your credit situation, it is time to find the right dealership to which to make an application. Start out with mainstream auto dealers and lenders. If you have not been successful with dealerships or are not satisfied with the rates they’re offering, look for look for a non-profit lender that offers personal loans. You can also try lenders who specialize in “subprime” loans. You may get better rates by arranging a pre-approved loan with a sub-prime lender. This can often be done through online lenders who specialize in financing cars for people with poor credit histories.
A word of warning: At this stage, each request for a credit report and score will have a minor negative impact on your FICO score (typically less than five points will be deducted) and if you’re shopping around a lot and already have a “subprime” score, this can really add up and undo all of the hard work you’ve already done.
The best way to prevent excessive credit inquiries from negatively impacting your credit score is to make them unnecessary by taking a copy of your credit report along with your credit score to the dealership. Provide a print-out of the report given by the credit bureau to the finance manager at a dealership, and don’t let them do a credit check until you’ve struck a deal. They should be able to evaluate whether or not you’ll qualify for financing form them based on the score you show them.
Be sure to bring in your scores from all three agencies, in case the dealership insists on using their preferred credit agency. This strategy will allow you to shop around for the best deal, but without lowering your chances for approval and better rates in the process.
Complete a lease assumption.
Another possible solution you may want to consider is a lease assumption. This involves taking over an in-process lease from another person who is no longer able to afford their lease payments or, for whatever reason, no longer wants or needs the car.
For example, if that person has 18 months left on their lease, you would simply assume the lease from that point and start making the payments as normal each month for the remaining 18 months. Note that the lease company that is involved in the takeover will still have to check and approve your credit. However in this, case the standard for approval is generally not as strict as it would normally be if you were signing up for a brand new lease from the leasing company.
At the end of the lease, you simply return the car to the leasing company. These kind of sellers often offer great cash incentives, like no down payment. Online companies can help facilitate lease transfers by matching lease “sellers” with appropriate “buyers” in their area– just search for “car lease assumption,” or “car lease takeover.”