7 Simple Steps to a Subprime Auto Loan | Edmunds

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7 Simple Steps to a Subprime Auto Loan

Even if Your Credit's a Mess, You Can Buy a Car

Buying a car can be a challenge for buyers with limited, new or poor credit. The good news is that loans are available for buyers in most credit situations. The trick is knowing how to access them. Do you have less than stellar credit? Downright bad credit? Here are some tips to help you get a loan, even if your credit has seen better days.

Before the Loan
This is the time to be realistic about your credit, learn your score and map out your car budget.

But first, some encouragement: Even if you have bad credit, you can still get a car loan. You will, however, pay a higher interest rate than will people with better credit. According to a recent report by Experian Automotive, 28 percent of new-car buyers and 54 percent of used-car buyers in the third quarter of 2014 had credit scores below 660. Customers with scores above 660 are generally considered to have good or great credit.

Borrowers with scores below 660 are seen as more of a credit risk, and can be grouped into one of three categories, based on score:

  • Nonprime: Borrowers with scores between 601 and 660
  • Subprime: Borrowers with scores between 501 and 600
  • Deep subprime: Borrowers with scores below 500

In the third quarter of 2014, subprime and deep subprime buyers made up 32 percent of used car loans, and a bit more than 10 percent of new-car loans.

Average used-car buyers with a nonprime credit score received an annual interest rate of 9.29 percent for their auto loans, according to the Experian report from the third quarter of 2014. A subprime buyer got an average interest rate of 15.72 percent. Deep subprime buyers had an average interest rate of 19 percent on their purchases in the same time period. Interest rates for new cars were about 6 percent less per category.

Know What You Can Afford
Back to being realistic about your situation, and what you can afford: If you're on a tight monthly budget, shopping for a used car will likely make the most sense, even when factoring in the lower interest rates offered on new cars. The average new-car loan among the nonprime, subprime and deep subprime credit groups in the third quarter of 2014 was $27,159 compared to $16,333 for used.

Here's how those numbers work out in real life for a 60-month loan amount of $16,333, using the average interest rate received by each group of borrowers with scores below 660.

  • Nonprime: 9.29 percent for 60 months = $341 per month
  • Subprime: 15.72 percent = $394 per month
  • Deep subprime: 19 percent = $423 per month

It's clear that if you're a deep subprime borrower looking for a $300 monthly payment, a loan amount of $16,000 won't work. If you have your heart set on buying a car in that range, you'll either need to save up enough of a down payment to get your loan amount down to about $11,500 (which, at 19 percent interest, amounts to a monthly payment of about $299) or look for a less expensive car. Understanding this before you start the shopping process will do more than help you save time: It will also save you the frustration of looking at cars that don't fit your budget.

If you don't know your score or are unsure about your overall credit standing, AnnualCreditReport.com, a free Web site, is a great place to start. Some online credit monitoring companies charge a fee (usually about $10) to access your credit score. And increasingly, credit card companies such as Discover and Citi are providing cardholders with free monthly reports of their scores. Without knowing your score, it is difficult to estimate your interest rate, and in turn, your new payment.

The score you receive online likely will not match the score you'll receive at a dealership. However, you'll have a firm idea of where you land in the credit spectrum. With that, you can start planning accordingly.

Once you have your score and an approximate expected annual percentage rate for the loan, you can use the Edmunds.com affordability calculator to determine how much car you can afford by payment. You also can use Edmunds' auto loan financial calculator.

Start Saving for a Down Payment
Every day, car shoppers buy vehicles with little or no down payment. However, if you're a shopper with subprime or deep subprime credit, the chances of buying a car with no down payment are slim. Many lenders will require "at least 10 percent down payment, or $1,000, whichever is greater," according to Martin Less, president of Nationwide Acceptance, a lender that works with people in the subprime market. Trade-in vehicles can also be used as down payment.

However, a trade-in by itself may not be enough. Depending on the severity of the blemishes on the borrower's credit report, some banks may require a cash down payment in addition to a trade-in that the car shopper owns outright. This shows the bank that the borrower is serious and committed to maintaining a loan. The more money (or trade equity) the buyer brings to the table, the better the chances of a favorable approval.

Applying for the Loan
Your first goal should be getting approved for an auto loan from your local bank or credit union. However, if you're unable to secure financing with your own bank or credit union, you may still have other options.

Many credit card companies offer auto loans. If you have a long-standing relationship with a credit card company, you may be able to secure an auto loan there. Or perhaps you've paid off an auto loan in the past. See if the bank that carried that loan will write you another one.

If these options aren't available to you, head to the car dealership. Most dealerships have processes in place to help get subprime loans approved, and will usually have working relationships with subprime lenders. Some of the dealerships that are proficient in subprime lending will regularly work with upwards of 10 subprime lenders. In some cases, dealerships will even have dedicated personnel whose job is getting subprime and deep subprime loans approved. This group is often called the special finance department.

Dealerships that regularly work with credit-challenged shoppers will know which lender will be most likely to approve your loan, based on your specific situation. Just as all buyers don't have the same credit challenges, not all lenders have the same requirements. A dealership might need to place a buyer with a recent bankruptcy with a different bank than a buyer who has a low score because of a recent divorce. A dealer who knows where to send a loan can be the difference between a shopper getting approved or not.

Documents You'll Need
Before heading to the dealership, have your paperwork in order. Lenders may need to see pay stubs or W-2 or 1099 forms to prove income. If you're in a line of work that has hard-to-prove income, such as a restaurant server who has a lot of income in cash tips, bring in bank statements that show a history of consistent cash deposits to your account. Some lenders will accept bank statements in place of, or in addition to, standard pay stubs.

A utility bill, rental agreement or mortgage statement from your current address is something else a lender will likely ask for as proof of residency. To establish residency, the lender will expect to see your name on the bill. Some banks may also accept cell phone bills. Knowing where a borrower lives does two things for a lender. First, it shows stability. A borrower who has lived in her home for 10 years is likely to stay put, and banks like stability. The second reason is that the bank wants to know where to send the repo truck if the borrower stops paying.

Bring recent documents. The lender will likely want to see proof of residency and income that are no more than 30 days old. Having these documents in hand when you arrive at the dealership can be the difference between getting a loan response in a few hours instead of a few days. In addition to documents, some lenders will ask for personal references. When requested, the lender will want names, phone numbers and addresses.

Picking the Right Car
It helps to understand that lenders do not view all cars with the same selling price the same way. Imagine two $12,000 vehicles: The first is a 3-year-old economy car with 36,000 miles and the other is a 10-year-old sports car with 120,000 miles. Although both cars have the same selling price, a lender may approve a loan on one vehicle and not the other. A subprime lender is more likely to approve the newer car with fewer miles.

Lenders use a complicated formula when deciding which cars to finance, and the criteria can vary among banks. The vehicle's age, mileage, history and the buyer's credit history all play a role in what will be approved. So if you're approved for financing, you may have to pick a car that gets a lender's OK, and it might not be the one you had your eye on. Prepare to be flexible. Also, that high interest rate you're going to pay may sting, but remember that for many buyers who are rebuilding credit, it's temporary.

"Generally, if somebody has made good payments for 18 months, assuming the customer hasn't created new credit problems, then there may be an opportunity to get a lower interest rate," says Less, of Nationwide Acceptance.

Your options could be trading in the car after you've established a good payment history and buying a different car with a lower interest rate. Or, once your credit is on a better footing, you could refinance the loan at a lower rate with a different lender.

Don't Be Afraid To Shop Around
Often, shoppers with poor credit will jump on the first deal for which they are approved. That's understandable, especially for a shopper who has been turned down a few times in the past. However, just because you've gotten an approval doesn't mean you have to sign a contract that makes you feel uneasy. If the deal you are offered doesn't sit right with you, shop around. The reality is that if one dealership can get you approved, chances are good another dealer can, too.

Having poor credit doesn't mean you're stuck with a bad deal, can't negotiate or can't shop for the car that's best for you.

Once You Get the Loan
Make your payments on time. When possible, consider making additional, or larger, payments on your loan. Those additional payments will look good on your credit report, make you look good in the eyes of the lender and save you money in interest while you have the loan.

If you run into trouble while paying the loan, tell the lender immediately. Some lenders will allow you to make small payments for a time, adding the remaining balance to the end of the loan. If the situation is dire, a bank may even allow a buyer to miss a payment or two while things get better.

"The most important thing they can do is keep communications going with the lender," Less says. "Let the lender know what the circumstances are and lenders will generally work with the customers through temporary problems."

To find a dealership that knows how to treat shoppers right, please visit Edmunds.com's Dealer Ratings and Reviews.

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