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Let's say you've made a few late payments on your bills. Perhaps you have a maxed-out credit card. Or maybe you bought more car than you actually needed and couldn't keep up with the payments. Hey, it happens. But now it's time to buy another car and you have serious doubts as to whether you'll get approved for a loan.
A few years ago, we tested the theory of buying a debt-free car as an alternative to buying at a used-car lot or a "buy here, pay here " dealership. We concluded that for some, the maintenance and repairs may prove too much for people to handle.
Buying a new car outright won't reestablish your credit. You'll need to take out a loan for that. But what options do you have? The "buy here, pay here" dealerships might be one alternative, but not all of them report your payment progress to the credit bureaus. Plus, you're still buying a used car that may require repairs. Is a new car out of the question? Not necessarily.
It is possible to buy a new car with bad credit — if you know where to look and how to prepare. Here's how this kind of car buying works and what to keep in mind throughout the process.
Why Would a Dealership Finance Your Car?
How can you buy a brand-new car when you have a spotty credit history? There are a number of reasons why a lender would let someone with a troubled credit history finance a new car.
From the lender's perspective, a new car has more value and therefore offers more collateral that can be reclaimed if the buyer fails to make payments. The lender also has the assurance that a new-car buyer will actually keep up with payments. His money won't be diverted to the costly repairs that sometimes befall older cars.
From the dealership perspective, a new car is an investment in a relationship that will pay off in other ways later on.
"Half the time, we're not making any money on the deals," says Rinaldi Halim, general manager for Nissan of Duarte. a dealership in Southern California that says it's proud of the fact it takes on clients in all credit tiers. "We want to have a relationship with that customer," Halim says.
One new-car sale won't yield much (if any) profit, Halim says. But it will pay dividends when customers refer their family and friends, resulting in more car sales, including some that will be profitable for the dealership. The sales also pay off when people get their vehicles serviced in the maintenance department. Years later, the initial customers will likely trade in those "no-profit" cars for new ones. The dealership will sell the initial cars as used ones. And if they've been well maintained, they will turn a tidy profit for the dealership.
Start Prepping Early
If you're someone who has bad credit but wants to buy new, it is best to start planning for it well in advance, as you would with any major purchase.
You need to start with your credit report to see how it would look to a lender. Run it at least three months before you plan on buying so you can take action on any outstanding items, recommends Rod Griffin, director of public education for credit reporting company Experian.
Annual Credit Report.com gives you one free report a year on each of the major credit reporting companies: Experian. Equifax and TransUnion. Take advantage of it.
Getting your actual credit score typically costs money, but your score will give you an idea of the credit tier into which you fall. Experian defines subprime (which includes deep subprime, as low as you can go) as a 619 score or below on its Vantage scale.
Once you get the free credit report, pay close attention to the section that points out potentially negative items, also called risk factors. Risk factors could be anything from an old debt that went to collection to a fine you had to pay in a civil court case.
Rather than viewing them as black marks on your credit, "These risk factors can empower you as a consumer to help rehabilitate your credit," Griffin says. The risk factors are present in all reports, so if you fix an issue you found on one credit report, the action will be reflected on all the other reports.
Experian says it offers an added benefit with its credit report and score. For $40, you get your credit score from Experian and a 35-minute session with a credit educator. This person will go over your report and point out items that need attention and give you tips on how to address it.
Get Pre-Approved and Choose a Dealer
Because your credit is bad, you will be paying a high interest rate, perhaps as high as 18 percent in
California, for example. But some rates still could be better than others. This is why it's important to seek approval from more than one lender.
To find out which car dealers may be willing to finance people with iffy credit, pay attention to radio commercials or billboards from dealerships that say things such as "Your job is your credit!" or "Bad credit? No Problem!" These are good places to start. Steer clear of the "buy here, pay here" lots, however, since they don't sell new cars.
Many dealership Web sites have credit applications you can fill out online to get pre-approved. If you don't see the application on the front page, it may be under the "Finance" tab.
Also, check with your own bank or credit union. They may be more willing to approve you since you already have an established financial relationship with them. You might also try Road Loans from Santander Consumer USA, which specializes in subprime loans.
Don't worry that filling out too many loan applications will harm your credit. "Lenders know you are searching for the best rate," Griffin says. As long as you apply for loans in a 14-day period, they will only count as one "hard" inquiry on your credit report.
Bring Documents To Show You're a Good Credit Risk
When you go into the dealership to talk about financing, you need to bring along some important paperwork. These items will allow a dealership to establish who you are and confirm that you have a job, that you have a history of making monthly payments on time and have friends or family the dealership can contact to find you if you stop making payments. Bring these items with you:
- The most recent pay stub from your job
- Your utility bill (gas, water, electricity)
- Your driver license
- Three personal references
Stay in Your Price Range and Look at the Total Costs
Most people know what they can afford for a monthly car payment. But that sometimes ignores the bigger picture. Just because you qualified to buy a $22,000 midsize sedan doesn't mean you should buy it. For example, if you scale back and purchase a $17,000 compact sedan, you'll free up $100 per month. This is money you could use for gas, insurance or to pay other bills.
"We love our leather seats and sunroofs," says Griffin, "but when your credit isn't stellar, it is better to look at a lower-end automobile."
A Typical Deal — and a Bad One
Halim gives an example of a deal made for someone with bad credit: a $16,000 Nissan Versa. minus a $1,000 bonus cash incentive, financed for 72 months with $1,000 down. The interest rate would be around 17.9 percent, which would bring the monthly payment to about $354. At the end of the six years, you would have paid $25,485 for that Versa.
These numbers will vary based on how much you're putting down, what you're financing and what you've been approved for, but it gives you a rough idea on what this type of deal looks like. A sizable percentage of the loan will be the interest ($9,927 in this example), but this is the reality when you're borrowing in this credit tier.
Just remember that it could be worse if you were dealing with a "buy here, pay here" car purchase. While talking to Halim, for example, we heard about a customer who had purchased a car from a "buy here, pay here" dealership and no longer wanted the car. The loan was for $4,200, to be paid over 36 months. The person already had made 22 payments of $322 and still owed $3,800 on the principal, thanks to an exorbitant interest rate. It approached the California legal maximum of 29.9 percent.
Resist the Urge To Trade Up
A number of new-car dealerships offer their credit-challenged customers the chance to trade into another vehicle without a significant increase in their monthly payment, provided they've made a year's worth of consecutive on-time payments. While it may be tempting to get out of a Nissan Sentra and into a Nissan Altima. for example, you will be adding more debt to your next loan.
If you want to move up to a larger or nicer car, a smarter strategy is to refinance the current loan for a lower interest rate and monthly payment, then stick out the loan until the initial car is paid off. When it's time to purchase your next car, you should be in a higher credit tier (assuming you've also done well on your other bills), and will qualify for a nicer car.
The New You
If you've done your credit homework, shopped within your price range and made all your payments, you've not only improved your credit score but also set up positive finance habits that will serve you well for years to come.