These days, having a reliable vehicle is important for many aspects of life. Traveling to and from work or school, getting to the grocery store, and being able to make medical appointments all often require a vehicle to get you where you need to go. But what happens if your car breaks down and needs significant repairs—or worse, needs to be replaced altogether? If finances are tight, you might need to take out an auto loan to get back on the road, which can be especially tricky if you happen to have a less-than-stellar credit score.
Thankfully, there’s good news: not all car loans lenders may require perfect credit. In fact, there are specific auto loans for bad credit to help those who need to make essential repairs to their vehicle. Let’s dive into the specifics around auto loans, and how bad credit auto loans may be the right solution for you.
How Auto Loans Work
An auto loan is money you borrow in order to buy a vehicle and can be used for both new and used cars, motorcycles, or trucks. Auto loans are secured loans, in which you put up your car as collateral in exchange for the money to purchase that vehicle. If you find yourself unable to pay back the loan, the lender can take your car in order to make up their losses—a process you may have heard of called “repossession.”
Auto loans are usually structured as installment loans, meaning in order to receive the money, you agree to pay back it back over time in scheduled chunks, or “installments.” This amount includes both the original sum of the loan (or the “principal”) plus interest and/or fees. Because secured loans are less risky for the lender (since they have guaranteed collateral if things go awry), they may come with a lower interest rate than unsecured loans—though as we’ll see in a moment, this isn’t the only factor that affects your interest rate.
Depending on your agreement, you may or may not be required to make a down payment to secure the loan. Even if you aren’t, though, putting up some cash at the outset will go immediately toward your principal, thereby lowering your overall cost in both monthly payments and charges. Until the car is completely paid off, including interest and/or any applicable fees, you technically don’t own it; rather, the lender is the owner, as they have put up the entire cost of the vehicle upfront.
You can apply for an auto loan directly from the vehicle manufacturer’s financing arm, or you can secure an auto loan from a third-party financial institution, like a bank, credit union, or a direct lender. You’ll usually see an auto loan term ranging between 36 to 72 months, with longer terms often resulting in a lower monthly payment. But it’s important to note that the longer you’re making payments on the loan, the more money you’re likely to pay overall for the car, since you’ll be paying charges for a longer period of time. Most borrowers typically have the option of paying off the loan before the term is over.
Auto loans differ from leases in that at the end of your term, you own the car, whereas leasing a car is essentially renting it from the dealer for a period of time, after which you’ll either give it back for a different one, or pay the difference to own it.
Why You Might Need an Auto Loan
Though auto loans are often used to purchase a vehicle directly from a dealer, there are other scenarios in which you may want (or need) to take out a loan for your car from a third-party institution. Here are a few situations where an auto loan can be helpful or necessary:
- Your car was damaged, and you need to make emergency repairs or replace it.
- You’re purchasing a vehicle from a private seller.
- Your car needs unscheduled maintenance.
Auto Loans and Your Credit Score
We hinted above that even though secured loans usually benefit borrowers in the form of a lower interest rate, there are other factors at play – one of them is your credit score.
Lenders often look at your credit score to help them assess their risk in lending you money, and how likely you are to repay them on time and in full. If you’ve demonstrated a good history of repaying your creditors—whether through a credit card, a home equity loan, or other type of credit—you may qualify for a higher sum of money and your interest rate may be lower. On the other hand, the higher of a risk you seem to be, the less comfortable the lender may feel in offering you money—so you’ll likely get hit with a higher interest rate.
Getting a car loan through a typical financial institution while having poor credit (or no credit history at all) can be nearly impossible at worst, and extremely expensive at best. Most banks will do a “hard” credit check, which lowers your credit score even further. You’ll typically be required to have someone else cosign your loan, guaranteeing that they’ll pay on your behalf if you fail to do so. Others may only consider you for subprime auto loans. Subprime auto loans (sometimes simply called “bad credit auto loans”) are offered to individuals with lower credit scores. Since the lender is taking on more risk by lending money to someone with a poorer credit history, subprime auto loans typically carry higher interest rates and more qualifications for approval. They also may not offer the option to pay off the loan early, and instead they may assess prepayment penalties for doing so. Why? Because the lender may want to receive as much income as possible, in the form of collected interest over the entire loan term.
Many people who apply for auto loan for bad credit may also be at a higher risk of falling victim to predatory lending practices. There may be a danger of getting stuck with an astronomical interest rate or other stringent measures that will put you underwater. And lastly, some lenders won’t issue auto loans for any other reason than the purchase of a new vehicle—so if you needed extra money for repairs or maintenance instead, you may be out of luck.
Getting an Auto Loan for Bad Credit
You may already be working hard enough to rebuild your credit score—you shouldn’t necessarily have to jump through hoops or accept a predatory subprime auto loan just to get yourself back on the road. That’s where different kinds of bad credit auto loans come in—specifically from direct lenders.
Some direct lenders may offer installment loans instead of bad credit auto loans, and with a different kind of terms. You can use the money toward fixing your current car, rather than solely for purchasing a new one.