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Tips for People With Bad Credit on How to Buy or Lease a Car

Updated on May 17, 2013

Tips for buying a car with bad credit

When buying a car with credit that is what the industry refers to as "sub-prime", you will have few choices on the type of car you purchase. It is the downside to not having a good credit score, whether you just need to build credit, or you have a habit of missing payments. The fact that this is considered a "higher risk" loan, the interest rate will reflect a higher rate based on your credit rating. So how do you get the best deal on a vehicle?

Consumer credit is based on the credit rating by Experian, Equifax, or Transunion credit reporting agencies. The scores are derived by your history of borrowing and making payments, including how many open accounts you have, and available credit (credit cards) that is considered unsecured credit. Your score is going to be important for a lender to take a look at, because a lender is going to quote an interest rate based on this score.

When you think about it, if you had a cousin who owned a home, their vehicles, and always paid cash for everything, and they asked you to borrow them would consider that a low risk loan to your relative. If your other cousin always is short on money, always is borrowing money from friends to get by, and has a habit of blowing their paycheck the day they get it, how are you going to feel about lending this relative money? Obviously you are much more comfortable lending money to cousin #1, because chances are they are going to pay you back. But lets look at cousin #2...what would make us feel comfortable about borrowing money to them? They own a motorcycle that you can "own" in 6 months if they don't repay the loan, and the motorcycle is worth a lot more than the money you have lent them. That sounds like a workable deal.

This is the way a lender views the borrowing of money also, what are the chances of repayment (credit score), and how does the lender stay in business? A lender who borrows money to a credit risk individual, but lends the money at interest rates that are low enough to be considered A+ ratings, will most likely go out of business over time. Because with a high risk credit loan, you have to expect a certain percentage NOT to make a payment, therefore lending money to these high risk people requires a way to average out the default rate to be able to still make money and still be lending money.

In the automotive business, dealers work with many banks that will lend money to borrowers that have less then excellent credit. It is good business for a dealer to be able to sell vehicles to people who aren't really good at making payments, because poor credit buyers make up about 40% of most dealers business. Leave 40% of your business out of buying vehicles, and you aren't going to sell a lot of cars, therefore dealers always work as many lenders as possible. Each lender has certain criteria that they prefer to make loans for. Some lenders want a larger down payment, others charge a high interest rate to offset the bad loans and still make money. Others may require a low debt to income ratio, others may base a loan on income alone + down payment.

The idea for banks is to minimize risk, while still lending money. In the example of the cousins, a bank may lend money at a low interest rate without any money down, because the credit report shows excellent payment history, or a low amount of debt to the income...a very low risk loan. The second cousin however, will not only pay a higher interest rate, but most likely will have to have a good down payment to even considering lending any money to them. The down payment will cover the default on the loan, with the bank getting the vehicle back and paying for it to be re-possessed, and they walk away without losing any money on the loan. Although that doesn't sound fair in some peoples minds, the fact that they may be the ONLY lender willing to borrow money to this cousin #2, so it makes for a tough I need a vehicle or not? The problem isn't the lenders problem, the problem is that you need to make payments on time and prove you can be trusted with managing your money.

The best way to finance a vehicle with less than good credit, is to first fill out a credit application prior to going to the dealership. I would recommend the bank where you have your checking account, or a credit union usually will have a better interest rate, but you have to join a credit union first. Once you have your credit reviewed, the bank should give you some idea of what THEY would lend you money for a vehicle. Without getting too caught up in what type of vehicle, you should have an idea of how much money you plan to borrow. A bank may pull your credit score, and offer a vehicle loan for up to $20,000...which is considered a pre-approval for a loan.

Do not fill out credit application after credit application, because doing so will eventually lower your credit score. The reason your score may drop, is that the reporting agencies will see you are applying for a lot of credit, which makes lenders nervous because you could be borrowing more money than you are capable of repaying, which will mean your credit will be tightened up via a lower score. On another note, if you bank tells you that they will not lend you any money for a vehicle, or that you have to have an unreasonable cash down for purchase, at least you know where you are regarding your ability to borrow. That doesn't mean you can't find a dealer that works with lenders that will give you a loan, because many dealers have inventory that fits a lenders criteria for security, and you still will have a good chance of getting a loan.

One of the main errors that people make on a credit application, is the amount of income that they report. Many people will put the NET amount they take home, which means what the check is at the end of the week or two weeks. Instead, you need to figure out what the GROSS income is, which is how much you make before deductions and taxes. If you are hourly, figure out what you work per week including overtime on a consistent basis, and multiply that by your hourly wage, and report that. This is a HUGE mistake that many applicants make in the sub-prime market.

At this point, it is time to start shopping for a vehicle that fits your budget. Keep in mind, the lender may tell you that they will loan you $20,000 but the vehicle may have to fit a few specifications. The lender will define the criteria such as it has to have less than 50,000 miles, it must be 5 years old or newer, and have an existing vehicle warranty. The reason the warranty comes into play, is that if the vehicle has a major problem, they know you won't have the money to pay for the repair, and at that point most borrowers will simply quit making payments and have the vehicle repossessed.

There is a good reason why buying a vehicle with less than good credit is good, and there are two reasons for this. The first reason is that you need a good reliable vehicle anyway, so borrowing money to purchase a newer trouble free car is the way to go Vs. an old vehicle that constantly gives you trouble. The second reason is that you are going to be rebuilding your credit or establishing credit, so make ALL the payments on time for at least a 12 month period and then re-finance the loan at a much lower interest rate. Although it isn't always true, the fact is if you pay ALL your bills on time for 12 months +, you will definitely be able to get a lower interest rate. Most people will buy a newer vehicle with a lower interest rate, which may mean the same monthly payment.

Where most bad credit people go wrong, is that they shop for a vehicle without having any idea of what they can afford based on their credit rating. First of all, it is frustrating to find a vehicle that you really love, to find out that you do not qualify for that vehicle, and you can only purchase a vehicle that you really don't like...but you need a vehicle. The second point is dealer may submit your application to several lenders, and the dealer may not offer the most favorable terms to maximize their profit. You need to know what is a reasonable interest rate, and what is not...and your interest rate believe it or not, IS negotiable!


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