What to expect when buying a car with bad credit

Auto financing options still exist, but expect to pay dearly

By Tamara E. Holmes

The last sound you want to hear when you're rebuilding your credit is the clank of a dying car.

Not only would a new car stretch an overburdened budget even tighter, but blemished credit means you won't qualify for the best financing deals. The news isn't all grim, however. Though lending isn't as loose as it used to be for car buyers with bad credit, there are still options out there.

Geoff Williams, a freelance writer based in Loveland, Ohio, found this out firsthand after he declared bankruptcy. "My car literally died on the freeway, and black smoke was coming out of it," says Williams. Though he and his wife had another car, "it wasn't a very good one," he says, so they shopped around for a used car. Although auto loan interest rates currently average between 6 percent and 7 percent, "my interest is high -- around 20 percent," says Williams, who details his road to financial recovery in the book "Living Well with Bad Credit." "But I pay around $430 a month for a really good Subaru. In my case, it worked out fine."

Of course, everyone with bad credit won't qualify for a traditional loan. According to Bandon, Ore.-based firm CNW Research, only one in 10 car loan applicants with FICO credit scores of 620 and below were approved through a bank, credit union or auto manufacturer's finance company in April. For applicants with credit scores between 620 and 749, eight out of 10 loans were approved.

But even if you find yourself denied, you're not destined to take the bus. A friend of Williams, unable to qualify for a loan due to credit problems, rents a car every month, Williams says. The car rental agency offers a discount for those who rent frequently, "so his price is comparable to what I'm paying," Williams says. "And in his case, he never has to worry about maintenance issues."

A recovering market
Gone are the days when practically anyone could stroll into a car dealership, plunk little or no money down and drive out with a new vehicle. But, "there are still a lot of financing options available and the landscape has improved from a year ago," says Eric Hoffman, a spokesman for Americans Well-Informed on Automobile Retailing Economics (AWARE), an organization comprised of auto dealers and finance companies that aims to educate consumers about car financing.

If you belong to a credit union, check those rates first. Then see if you can get a better offer from a local bank or the dealer itself. "If you have less-than-stellar credit, shopping around is even more important because it will give you a broader gauge for what different financial institutions are willing to offer," Hoffman says.

In 2010, more than 2.3 million vehicles are expected to be financed via buy-here, pay-here dealers, up from 1.84 million vehicles in 2009 and 1.32 million in 2000, according to CNW Research.

The person who takes advantage of subprime credit offers, such as those offered by buy-here, pay-here dealers, is "someone who is simply looking for transportation to get them to and from work and to do basic errands," Reed says. "They are not looking for something fancy, but instead are seeking a vehicle that meets their basic needs."

Temper expectations
Before exploring any auto financing options with bad credit, make sure your expectations are realistic. "You're not going to get the 0 percent financing that's offered on the TV commercial," says Hoffman. 

In fact, interest can be as high as 29 percent, Reed says, though "a guesstimate is normally around 20 percent," she adds.

If you have a low credit score, you'll likely be expected to put down a larger down payment, which is "designed to offset the risk the lender or dealer is taking by financing the consumer," Reed says. 

While your credit score is a big determinant in how much of a down payment and interest you'll pay, there are other factors as well. If you've lived in your current home for a long period of time, that shows stability. Likewise, if you have a steady job and can show a stable employment history, you'll likely be seen as less of a risk.

References can also play a role. A list of people who can verify that you're responsible and likely to pay your debts can also lead to an extension of credit with better terms, Reed says.

Once you get approved, know that you can always refinance to better terms if your credit score improves -- something that's likely to happen as you make those car payments on time. "It is a good opportunity to be able to build better credit for the future," says Hoffman.

See related: Help for bad credit, How to rent a home with bad credit, How bad credit can affect your job search, How bad credit affects a new marriage, Don't say I do to bad credit, How to rent a home with bad credit, Here's how to help young adults with bad credit

Published: May 21, 2010

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