It's possible to get approved for an auto loan if you have bad credit (sometimes called "deep subprime" credit), meaning a credit score under 580. But in many cases, options can be costly. To improve your odds of getting approved for a relatively affordable loan, follow these steps.
1. Check Your Credit Score and Credit Report
Your credit score has a significant impact on your ability to get approved for a car loan, as well as the terms of your financing.
The average interest rate for borrowers during the first quarter of 2023 with deep subprime credit is 14.08% for a new car and 21.32% for a used car, according to Experian's State of the Automotive Finance Market report. In contrast, borrowers with the best credit scores qualify for an average rate of 5.18% for new cars and 6.79% for new cars.
As a result, it's important to check your credit score and review your credit reports to gauge your overall credit health. If you have some time before you need to buy a car, look for areas you can address, such as paying down credit card balances or getting caught up on past-due payments, to potentially improve your credit score before you apply.
2. Know How Much Car You Can Afford
The average auto loan balance for 2022 was $22,612, according to Experian, which can be very costly if you can't qualify for a low interest rate.
Before you start shopping around for a car, consider how much you can afford to pay. In addition to the monthly loan payment, you'll also need to consider insurance premiums, fuel costs, maintenance and repairs and other associated costs.
Take a look at your budget to get an idea of what you can comfortably afford without sacrificing other financial goals or obligations. Remember, though, that while getting on a longer repayment term can reduce your monthly loan payment, it'll result in higher total interest charges, which can be especially detrimental to your finances if you have a high interest rate.
3. Save for a Down Payment
If you have poor credit, the lender may require a down payment for you to get approved for a loan. This amount goes directly toward the purchase of your vehicle, and the remaining amount of the purchase will be financed and paid back over time.
When buying a car, the more you can put down, the lower your loan amount—and monthly payment—can be. Additionally, a larger down payment reduces risk to your lender, which may help you secure a lower interest rate on your loan and save you money over time.
Coming up with a down payment isn't always easy, though, so you may consider delaying your car purchase to save for a larger one. Doing this could make you a more competitive applicant, lower the amount you owe and help you lock in a lower interest rate.
If you don't already have one, consider opening a high-yield savings account to make the most of your down payment fund.
4. Compare Auto Loan Offers
After you get all your affairs in order and you're ready to apply for a loan, take some time to shop around first. Potential options include:
- Captive financing: When buying a new car, you may be able to finance the purchase directly with the manufacturer.
- Dealer-arranged financing: In this situation, the dealer works with different lenders to find and obtain a loan for your vehicle. Once you apply, you may get several loan options from which you can pick the one with the best terms. However, dealers may tack on a margin to your interest rate as compensation for the service.
- Banks and credit unions: Traditional banks and credit unions may offer direct auto loans, where you receive a preapproval that you can take to the dealership. This could be a good option for people who already have an established relationship with a bank or credit union, as they may overlook blemishes in your credit history and use your experience with their institution as evidence of your creditworthiness.
- Online lenders: Many online lenders can offer low interest rates on auto loans because they don't have the overhead costs of a physical branch network. These lenders also typically offer prequalification, which allows you to see potential offers without impacting your credit score. In some cases, you can even use a single aggregation website that allows you to use one application to receive several loan offers. Just be wary of unfamiliar companies and do your research to determine whether a lender you're considering is reputable and offering a fair deal.
- Buy here, pay here (BHPH): BHPH dealers specialize in working with people that have no credit or poor credit. Instead of sending your loan to an outside lender, they finance the purchase of the vehicles themselves. There are many downsides to this type of financing, however, including high interest rates, high down payment requirements and a potentially limited vehicle selection.
As you search for the loan with the best terms and lowest interest rate, you may end up applying with several lenders. By applying with all of them in the span of 14 to 45 days, however, the multiple hard inquiries will be grouped together into one for credit-scoring purposes and shouldn't impact your credit score too significantly.
5. Consider Getting a Cosigner
A cosigner is a person that agrees to apply for a loan with you and make the loan payments if you can't. Cosigners typically have established good credit and give the lender peace of mind in situations where the primary applicant has a less-than-perfect credit history. If you end up missing payments or defaulting, there will likely be credit consequences for both you and your cosigner.
Build Your Credit to Improve Your Future Financing Options
It can take time to rebuild a bad credit score, so while you may be stuck with a high-interest auto loan right now, that doesn't need to always be the case.
After you receive your auto loan, continue to monitor your credit for opportunities to build and maintain a good credit history. If you have some negative items on your credit report, their impact may diminish over time, especially if you demonstrate good credit habits going forward.
As your credit score improves, you may have an opportunity to refinance your auto loan at a lower interest rate, or at least qualify for a more affordable auto loan the next time you buy a car.