How to Buy a Car with Bad Credit

Buying a car is possible even if you don't have a good credit score. The most common issue that credit-challenged car shoppers struggle with when arranging financing is cost. Those with bad credit end up paying more in interest than those with good credit. The second issue is that some manufacturer-sponsored incentives like cash discounts, zero money down, and special loan terms may exclude those who are not considered “well-qualified buyers.”

What is Bad Credit?

Bad credit is a general term, but we can help those who may be concerned to understand where they stand. There are really three primary issues to cover. Those are the following:

• Current credit score
• Debt to income ratio
• Current late payments

It is easy to rely on one's “credit score” as the only metric by which one’s creditworthiness is judged, but this is not really the case.

A credit score, a.k.a. FICO score, below around 600 or lower is considered "fair." Below 580, some lenders simply move your application to a different pile for further consideration or opt not to provide you with a loan offer. Experian says that any score of 579 or below is considered "very poor."

A score from 580 to 669 is considered “fair.” In this range, you may qualify for better terms than those with a score below 579. However, expect that your lender will do what is called a “hard credit pull” to look closer at your credit history before giving you a loan, or approving you for one in advance of a purchase. Your lender is going to want to see how your recent credit lines are being managed. Do you have recent overdue payments? If so, the lender will wonder why you feel you can take on more debt given the fact that your existing lenders are waiting to be paid.

Another angle on your creditworthiness is your debt to income ratio (DTI). Lenders want to see how much debt you are presently carrying and they will compare that number to your earnings to determine your ability to successfully make payments on a new loan.

Below is a chart to help illustrate credit score rating scales and the likelihood of loan approval.

FICO Credit Score Rating Scale

Clean Up Your Credit Before Buying a Car

If you decided twenty minutes ago that you need a new car by the end of the day, bad credit will slow your roll fast. Step back, check your credit report (it’s free) and look for the causes of your low score. There may be errors, so compare all of the line items with your history of loans and credit lines to ensure that everything is accurate. If it is not, you can contact the credit agencies to help you resolve any errors. Here is a list to help you get started.

When you look over your credit, see if you find any past due payments. If you have any, are they a surprise? Perhaps you can resolve those by contacting the lender and arranging a payment or payment plan. Correcting overdue payments may be the quickest way to help move the needle in the right direction.

Another consideration may be outstanding loans that are very close to being paid off. Credit experts say that paying off your oldest credit lines if they are in good shape (no past due payments) may actually hurt your score.

Experian says that your credit score is made up of the following parameters. The percents indicate what portion they represent when your credit score is calculated:

• Payment history (35%)
• Credit usage (30%)
• Age of credit accounts (15%)
• Credit mix (10%)
• New credit inquiries (10%)

How can you improve your credit score and also avoid accidentally making it worse? Here is your checklist:

1. Look closely at your score so you understand trouble spots.
2. Work with the three credit reporting agencies to correct any errors.
3. Pay any overdue balances or work out a plan to do so.
4. Shoot for using only 30% of your credit allowance on any given credit card.
5. Don’t close any old credit cards out, just pay them off and keep them open.
6. Don’t do too many hard credit pulls, and bunch them together, if you do more than one.
7. Ask a trusted relative to add you as an authorized user on a perfect account.
8. Don’t pay off your oldest loans if they are in great shape.

Creating Good Credit Habits

Good habits help you maintain good credit and can improve poor credit over time. Creating a budget can help you in many ways. In addition to helping you avoid overspending on things you want, but don't actually need, a budget also helps with anxiety when you need to make a car or home repair, or deal with a medical or dental issue. If you’ve budgeted for such things, then paying for them is part of your plan, not an unexpected calamity.

Credit monitoring services can help you to understand any changes that occur to your credit. Free credit monitoring is available from many sources.

Check Interest Rates

Folks who have earned credit scores above 700 can find low interest loans for cars in every direction. Those with credit scores below 700 have a harder task ahead. Below is a listing of average auto loan interest rates by credit score. As you can see, a higher credit score means paying less interest over the life of your loan.

Read more on Average Auto Loan Rates here.

Check for Deals, Good Times to Buy

If you have less than stellar credit, some special incentives and deals may not be available to you. But some may well be. Certain lease deals on entry-level models can be very tempting deals. When a new model is released for sale, call dealers to find out if they have any leftover models from the prior generation they wish to make a deal on. The best time to buy any vehicle is the last day of its availability before the all-new generation arrives. Ask local dealers if any loaners or test-drive models may be coming up for sale.

Create a Budget and Stick to it

Every adult and every family needs a budget. If you need help developing an overall budget, check out this story from Dave Ramsey. He’s an expert on personal finance issues. We’re the car nuts, so we can help with some details on your transportation section.

Budget your vehicle this way:

• Your down payment savings plan - This should not end when you buy a car. You should start saving for the next one immediately.
• Your monthly loan, including both interest and principal.
• Your fuel or energy costs.
• Your insurance. Don’t forget to budget for a deductible in case of an emergency.
• Your maintenance and repair costs.
• Your costs associated with registration and vehicle taxes.

Skip the Extras

One way to manage your costs is to avoid financing any dealer add-ons. Skip the extended warranty policy. You can always get one later and you can shop for it separately. Don’t add paint protection film, interior treatments, or any other snake oil. Do not purchase a prepaid maintenance plan. If you have questions about whether or not you need a certain option, you can always ask the Car Talk Community here.

Getting Pre-Approved

When you shop for a vehicle as a person who has less than great credit, you should plan to do some preparation before heading out to pick out the model you want. Work in advance with lenders to first be prequalified for a loan. A prequalification won’t hurt your credit because the lender will do a soft pull of your credit report.

Next, finalize your budget and ask the best or best pair of lenders to pre-approve you at the same time. Keeping your pre-approvals close to one another in time helps maintain your credit score. Once you know your pre-approval details, you can then start to shop for a vehicle that fits your budget.

If you visit a dealer who can beat the loan pre-approval you have already received, that’s great. Dealers may even offer you a slightly better deal if you obtain lending through their sources. But read the fine print closely.

Understand the True Cost of Owning a Car

Many car shoppers incorrectly assume that the biggest part of the total cost of ownership of a vehicle is the vehicle itself. It seems obvious. But it is not correct. For most conventional vehicles, the largest cost of ownership category is not the depreciation of the car, but the fuel you put in it. EVs are not this way, and hybrids are much better than regular gassers. If you want to have more money for more car, buy one that has an EPA Combined fuel economy estimate of 40 MPG or more. There are dozens of models that fit this description, and many are the most reliable and also the quickest in their class.

Repairs are also a big contributor to the total cost of ownership. So why not choose a model that offers included maintenance if you are shopping new? Hyundai offers three years of included maintenance, but Kia offers zero. Toyota, Honda, and Volkswagen all offer included maintenance for all of their new cars, yet many competing brands do not.

And why not pick a model with a great track record of reliability? Sure, the Toyotas are always a good choice, but vehicles like the Mazda CX-5 lead their segments very quietly. Check Consumer Reports for reliability histories by model and year.

The true cost of owning a car goes way beyond the monthly car payment. An easy rule of thumb is that the total cost of ownership will be 50% the car loan and 50% fuel, maintenance and repairs, and insurance.

Read more on How Much Income Needed to Buy a Car here.

Shop Around for Best Deals

Car Talk has a staff that tests hundreds of new cars per year. Want to know a secret? There are very, very few bad vehicles today. In fact, many in the same segment may be so similar it’s a toss-up as to which is the “best” one. We suggest being flexible with your model choice.

Have your heart set on a Civic? It’s a fine model. But compare it to the Hyundai Elantra and Toyota Corolla. Each has some plusses, and with inventory tight, being flexible may help you save money.

Shopping used? If your budget is tight, value a car still under its manufacturer’s powertrain warranty more than any other factor. Certified pre-owned vehicles sold by branded dealerships come with warranties that are almost always longer than a year. Some personal sales of used vehicles may have a transferable aftermarket warranty. Why not ensure you don’t have a repair to pay for shortly after you buy?

Read more on the Best Time to Buy a Car here.

The Magic of Cosigners

If you have a friend or family member who is willing to cosign a loan for you, you may find that more doors open. The cosigner will be on the hook to pay if you don’t, so choose your cosigner with care.

A Polite Warning About Used Car Financing

If you have a lower credit score, somewhere below 600 and are shopping for used cars, be aware that you may be targeted by some predatory used car dealers and lenders. These are sometimes referred to as Buy Here, Pay Here car dealerships. These places advertise that anyone will be approved, but the interest rates you will end up paying will be astronomically high.

There exists in America a separate finance world for those with poor credit combined with a poor payment history. If you are shopping for a low-cost used car that the dealer will finance at a rate over 10%, seek the advice of a friend or family member with more financial experience before signing anything.

Read more on How to Buy a Car here.

Read more on the Best Time to Buy a Car here.