Bad Credit Auto Loans are More Available, But Still Pricey

Shopping for an auto loan to pay for your new ride? Have bad credit? This time last year, I would’ve said you were out of luck. But it seems that an increasing number of lenders are offering bad-credit auto loans again. Of course, you’ll pay a premium for it, in the form of higher interest.

The number of people with bad credit has increased steadily since the recent recession. Millions of people have had to max out their credit cards in the wake of a job loss. Many more have been foreclosed upon by their mortgage lenders. Both of these things will put your credit through the wringer.

A low credit score can reduce your chances of getting any type of financing, and that goes for auto loans as well. Ever since the economy tanked in 2008, banks and lenders have backed away from making bad-credit auto loans. These are loans made to people with a subprime credit score, which is usually defined as being below 620 on the FICO scoring scale.

Over the last few years, subprime borrowers would’ve had a hard time getting an auto loan with bad credit. But things are starting to change.

Bad Credit Auto Loans More Accessible?

Experian Automotive compiles (and sells) data related to consumers, especially those who are in the market for a new car. Yes, this is the same Experian that maintains credit reports on consumers in the U.S.

According to their recent analysis, consumers with bad credit scores are finding it easier to get approved for an auto loan. The percentage of non-prime borrowers who obtained financing for a new car rose from 18 to 22 percent over the last year.

That’s not a huge increase by any means. But it does show that some lenders are more willing to make bad-credit auto loans these days.

Note: Experian defines a “non-prime” car buyer as someone with a credit score below 700 on their scale. This bar is set a bit higher than the traditional “subprime” category used by mortgage lenders. But for the most part, these terms are interchangeable. These borrowers will have a harder time finding an auto loan, and they’ll pay a higher interest rate if they do find financing.

This is good news for responsible borrowers who suffered credit damage resulting from an isolated event (like a foreclosure during the housing crisis). I’ve always felt that a single negative event should not overshadow a lifetime of responsible credit usage. So if you’re one of these borrowers, you may find it easier to qualify for a bad credit loan.

You’ll Pay a Lot More Interest

There’s a downside to this type of financing, and you can probably guess what it is. I gave it away with the subtitle above. If you get approved for an auto loan with bad credit, the lender will probably slap you with a higher-than-average interest rate. How much higher will depend on the exact nature of your score, along with other factors.

When this article was published, the average rate for a 4-year auto loan on a used car was 4.17% (source: Bankrate.com). The average rate for new-car financing was slightly higher at 4.36%. However, if you have a bad credit score, you won’t get a rate anywhere near this level. You might even be pushed into the double-digit range.

Why? Because your credit score tells lenders how likely you are to repay your debts — statistically, at least. It’s a measure of risk. That’s why bad-credit auto loans usually come with a much higher interest rate. It suggests that the borrower brings more risk, so the lender prices the loan accordingly. They charge more when there is a higher likelihood of default. Mortgage lenders do the same thing, by the way.

Percentages aren’t very telling by themselves. So let’s look at a real-life example to see how much more you might pay with a bad credit score. I used the car-payment calculator at Bankrate.com to come up with these numbers.

  • John has an excellent credit score in the upper-700 range. He has a history of paying all of his debts on time, including his previous auto loans. So the lender gives him an interest rate that is better than the average mentioned above. He gets a rate of 3.75% on a $20,000 auto loan. When spread over four years, his payments come out to around $449 per month.
  • Frank has bad credit as the result of some unpaid bills in the past. So he looks like a bigger risk, as far as the financing company is concerned. They charge him an interest rate of 10% on the loan. By definition, he is getting a bad-credit auto loan. Here again, the amount financed is $20,000 spread over four years. Frank’s payments come out to around $507 per month.

So Frank is paying $58 dollars more than John each month, just because his credit is bad. When you spread that out over the full term of the loan (four years), you see that Frank is paying an extra $2,780 in interest charges.

This is what I mean when I say bad-credit auto loans are pricey. Of course, if you need a car to get to work or school, then you have little choice in the matter. You need a car. There’s not much you can do to change that.

But there are plenty of things you can do to improve your credit score over time. Here’s a detailed list of those things. And you can start by making those car payments on time!