How to buy a car with bad credit

Low credit is generally defined as a credit score less than 630. You can have a low credit score for a variety of reasons, including a pattern of making late payments to lenders, the results of identity theft or simply not having enough years of credit history. Your credit score determines the interest rate you pay on your car loan, and a low score typically means a higher interest rate.

The good news is you aren't necessarily destined to pay a high interest rate on your auto loan for five or more years just because your credit score isn't perfect. This guide will help you learn how your credit score affects your car loan and find options for getting a car loan with affordable payments if you have bad credit.

How we researched bad credit car loans: To find out what car loan options are available for consumers with bad credit, we spoke to nationally recognized credit expert John Ulzheimer, who has more than 24 years of experience in the consumer credit industry, and Beverly Harzog, consumer credit expert and author of "The Debt Escape Plan."

We also reviewed and consulted several publications and online resources about credit scores and securing auto loans. These sources provided additional insight on how credit bureaus calculate scores, how they can negatively impact your ability to get low interest rates and what you can do to keep yourself from getting even further into debt when you have to make a car purchase with bad credit.

8 tips for buying a car with bad credit

Having a low credit score can make it difficult to buy a car. Car dealerships typically raise interest rates for buyers with poor credit scores, also called subprime buyers, because lenders consider these buyers greater potential risks than those with good credit.

If you have bad credit, it's crucial to reach out to a reputable bank or lender to see what options are available for financing your auto loan instead of automatically accepting a high interest rate. Follow these steps if you're looking to buy a car with less than ideal credit.

1. Ask yourself how badly you need a car

Are you buying a car because you don't have any other mode of transportation? Or is your car more of a luxury item? Both Ulzheimer and Harzog recommend only buying a car with bad credit if you are in an emergency situation.

Before you shop for a car, take a closer look at your situation to see if you have another option, such as keeping your current car, carpooling or using public transportation for six months to a year while you work on rebuilding your credit.

"If getting a car isn't an emergency, I suggest getting a secured credit card and spending at least six months (a year is better, though) responsibly using the card," Harzog says.

A secured card is one way to build credit when you don't have a credit history, and it can also be used to rebuild credit if you have a history of late payments. You make a deposit in the bank to secure the card, and you get that deposit back when you close your account. You can also work with a credit repair company to boost your score and get rid of inaccuracies.

If you must get a car and have bad credit, prepare yourself for a loan with a higher interest rate. If you have a poor credit score because of your payment history, be sure to pay future bills on time. Even a few months of paying bills on time can raise your credit score. If you can push your vehicle purchase off for a month or two, you might end up with a high enough credit score to get a slightly better interest rate.

2. Check your credit report

Don't take a dealership's claim that you have bad credit at face value. You can perform a free credit report check once every year. Get your report, make sure it’s accurate and check for any suspicious activity. Bring your credit report with you when you meet with potential lenders so you're on the same page when you discuss your financing options.

3. Shop around

"Don't think that just because you have bad credit you can't get a car loan," Ulzheimer says. In addition, "don't just assume that your credit is bad." Your definition of bad credit might not be the same as your lender's definition, and lenders have different requirements. Be sure to get quotes from multiple lenders so you don’t let one take advantage of you.

4. Limit your search to a two-week timeframe

It's a cruel irony that applying for loans means lenders check your credit history, and each hard pull on your credit history has a slight negative impact on your credit score. The good news is that scoring models usually count every credit inquiry performed by an auto loan lender within a two-week time frame as just one inquiry. Some lenders also prequalify you for a loan with only a soft pull, which does not affect your credit score.

Because of this, it's important to only complete a credit application for an auto loan when you are actually ready to take one out. Otherwise, you risk making your credit score problem worse.

5. Opt for a shorter loan term

You might have lower monthly payments with a five-year versus a three-year loan, but pay attention to the interest rate. Generally, interest rates are lower for short-term loans, meaning you pay less for your car overall. Plus, you pay off your car loan earlier, which lets you focus on paying off other debts.

6. Look for newer versus older vehicles

Common sense might tell you an older vehicle costs less, but the truth is older vehicles tend to come with higher interest rates than newer ones. Ulzheimer recommends to look at new cars first and then newer used cars — these are the cars that tend to have the best financing options.

7. Get preapproved

While it’s not required, getting preapproved for a loan at a bank or credit union could help make your car search easier. To get preapproved, you submit an inquiry or meet with a lender. The lender reviews your income, credit rating and other factors to determine your creditworthiness.

If approved, the lender lets you know how much you can finance, and you’ll be able to take preapproval paperwork and information with you when you start shopping for a car. Knowing the preapproval amount can help you stay on track and within budget while shopping.

8. Consider getting a cosigner

Depending on your situation, getting a cosigner might be your best option to get a loan at a reasonable interest rate. Consider looking for a cosigner if:

• Your income is lower than the minimum requirement for a car loan
• You have bad credit
• Your debt-to-income ratio is too high to qualify for a loan
• You have a variable income

Your cosigner is responsible for making your monthly payment if you can’t fulfill your loan obligations, so only take this approach if you are confident you can make your payments in full and on time. Using a cosigner lets you leverage that person’s credit score to get a better interest rate or loan terms.

How bad credit affects your car loan

In general, a credit score of 740 or higher gets you the lowest interest rate on an auto loan. If you have perfect credit, you might be able to score a car loan as low as 0%. If you have a poor credit score, you might be looking at interest rates up to 20% or higher. That can add up to paying thousands of dollars more for a car loan with bad credit versus good credit.

Lenders want confidence that borrowers are likely to pay the loan back on time and in full, which is why people with good to great credit get the best interest rates. They pose a low risk based on their credit history, and lenders feel assured these borrowers will pay their debt back responsibly.

Consumers with bad credit, on the other hand, are perceived as higher risks by lenders. Things like missed payments, defaulted loans and a high debt-to-income ratio are red flags for lenders, and they charge a high interest rate to compensate for the increased lending risk.

In addition to reviewing your credit score, lenders also look at other factors not included in your credit report, including:

• Your income
• What type of loan you are trying to get
• Your work history
• How long you have worked at your current job

What to avoid when shopping for an auto loan

There are a few red flags to watch out for when shopping for a car. Some of the most common tips to avoid these are:

Don't shop at a "buy here, pay here" lot

You might have heard commercials from local car dealerships targeting subprime buyers, but be wary. Those "buy here, pay here" dealerships generally charge more money for cars than they are worth.

"Buying a car from one of these lots won't necessarily hurt your credit score, but it won't help it either," Ulzheimer says. These lots typically don't report to credit reporting agencies, meaning your credit score remains the same even if you make all of your loan payments on time and in full.

Don't let yourself be misled by verbal promises

It's easy to believe a salesman, particularly when they're telling you things you want to hear about your car loan. Don't believe your car salesman or finance and insurance officer based solely on verbal promises. Make sure everything is in writing before you agree to terms.

Don't go car shopping without checking out your options

A lot of people aren’t aware of what their credit score is and what options they have for financing based on it. Do some research before car shopping to see what rates you qualify for. If you’re uninformed, you could wind up agreeing to an interest rate that is higher than what you're eligible for.

In addition, avoid talking about yourself as a high-risk borrower. The more desperate you appear, the more likely you are to have interest points tacked on unnecessarily, which just translates to money in your salesman's pocket.

Don't spring for extras

When you're already tight on cash, you don't need to pay for extras that aren't necessarily worth the money in the first place. Things like extended auto warranties, GAP insurance and credit life policies are all optional (regardless of what your finance and insurance officer tells you) and could end up costing thousands of additional dollars over the life of your loan.

Don't sign anything without reading and understanding it thoroughly

Read everything carefully before you sign a contract and walk away. Neglecting this could end up costing you thousands of dollars and/or making your credit even worse, depending on what is included in your contract.

Ask questions about anything you don't understand and don't be afraid to walk away and tell the F&I office that you need some time to think it over before you sign. They'll want your business when you're ready to give it to them, no matter how much of a fuss they make at the thought of you leaving.

Don't leave the dealership before you finalize your auto financing

This is a cruel trick played on eager buyers who just want a vehicle that can drive. Some dealerships will offer you financing based on final approval and let you drive off the lot before your financing is actually finalized.

You, the unsuspecting customer, are later told that your original financing wasn't approved, and you’re slapped with a significantly higher finance rate. Don't fall for this. Leave the lot in your old car, take the bus, walk home or catch a ride with a friend instead of driving off the lot in a car without approved financing.

What to do if you buy an auto loan with a high interest rate

If you’ve already purchased a car and your loan has higher interest rates than you’d like, you have a couple of options.

Refinance

"A lot of people don't realize they can refinance their auto loans," Ulzheimer says. "They think of refinancing for their mortgage rate or federal student loan, but they don't know that they can get a better rate on their auto loan by refinancing when their credit score gets better."

If you absolutely need a car and you end up with a high interest rate, keep in mind that you can refinance in 12 months (or whenever your credit score goes back up). Talk to your lender to find out what your options are. You don't need to pay 30% interest for five years if your credit score improves and lets you get better financing.

Pay more than the minimum payment, and pay on time

Another way to reduce the amount of interest you pay is to shorten your loan by paying more than the minimum payment each month. If you can't pay more than the minimum, at least make sure that you make your payments on time since, even at a high interest rate, an auto loan will help your FICO score. Make sure your lender lets you prepay your loan, and ask a representative if there are any prepayment penalties or fees.