While that new car smell can make some buyers downright giddy, it stinks to have to overpay for a car loan because of bad credit. Subprime loans, which are made to borrowers with a credit score of less than 620, typically come with higher rates and steeper fees, but lure buyers in with longer terms that mask the higher overall costs.
If you’ve got a relatively low credit score, you may wind up with a loan you’ll struggle to pay, and end up paying late or defaulting on it altogether. Borrowers are also likely to find themselves paying for a car long after it’s gone to auto heaven — because the terms of their loan may last longer than the life of the vehicle itself. “That means, you could still be paying on an asset that no longer works,” Matthew Frankel, personal finance specialist for the Motley Fool said in a phone interview.
Auto loan delinquencies are rising at a higher rate than those for credit cards and mortgages, CNBC reported, even though overall delinquency rates for consumer debt remain at historic lows. Below you can see a chartthat shows how much higher delinquency rates (the percent of loans paid more than a few months late) are for for people with credit scores below 620 than they are for everyone else:
With at least 90% of all auto transactions made through finance or lease, and Americans owing a collective $1.17 trillion in car loans at the end of the first quarter of 2017, there’s a good chance you are either paying off a car loan now — or will be some day.
That’s why car buyers, especially those considered to be subprime, should be cautious with their financing. The number-one way to avoid overpaying for a loan is to get the best deal on your car in the first place. That usually means buying used: New cars lose 10% of their value right after you purchase them, and buying used means you’ll get more car for less money.
Once you’ve got the price down, see if you can pay all or part in cash to avoid paying interest on a loan. Don’t have enough funds? Then focus on getting the best deal on your loan. Assuming your credit is less than stellar, here are three crucial steps to ensure you get the best loan deal possible.
1. Know your “numbers”
It’s common sense: Having a grasp on fees and pricing before you decide on a purchase will position you to score the best deal possible. The average rate for a 60-month new car loan is about 14% if your FICO score is between 500 and 619, for example, versus 3.56% if it’s between 720 and 850. (Check the latest rates here, which can be broken down by credit tiers.) Make sure you aren’t being shortchanged, and aim for deals that are more favorable to you than the average person in your tier — not less.
And don’t forget to factor in fees to figure out your total cost. “The more subprime of a borrower you are, the more you can be charged in fees,” Frankel noted. Origination fees are typically $500, but they can run as high as $1,500 — so explore as many options as possible, he added.
Don’t forget to double-check your credit score, too, as any inaccuracies can lower your score and increase your loan costs. (Go to AnnualCreditReport to get a free report.) Correcting errors may give your score a big boost.
2. Comparison shop rates — and total cost
Like home-buying, shopping for a car is an emotional process, which can possibly get you into trouble. A slick dealer could find a way for you to score your dream car with a low monthly payment, which may sound good at the dealership, but loses its luster in the months and years spent making payments. “You could end up with an 84-month loan at 28% on a 10-year-old vehicle,” Frankel said. Over time, that adds up to an ugly number.
Borrowers should obtain quotes from several lenders to get a good idea of what is realistically affordable. “Generally speaking, lenders like Wells Fargo and Ally Bank have been decent for subprime loans,” according to Frankel. And no matter the lander, “if [your credit score is] borderline, like around 600, you may be able to get a loan. It never hurts to ask.”
In addition to national banks and credit unions, check with local and regional banks. You may get a better deal with a bank you already do business with, such as through your checking or savings account, since you already have money deposited with them. And don’t forget to check with your employer or home insurance company, as they may have good deals, too.
3. Always chose the shortest term possible
While it may be tempting to pay less per month for a fancier car, you will end up paying more in the long run, Frankel advised. “For example if you purchase a $10,000 vehicle at a subprime rate of 16%, you will end up paying about $2,000 more opting for the 72 month versus a 48 month loan.”
Risk factors of a lengthy term include being underwater with your loan (getting stuck with a car that’s less valuable than what you paid for), paying more than you should and having to remain in the vehicle for years on end.
Bear in mind you’ll have to pay for maintenance and repairs on an aging vehicle, too. On average, cars with over 100,000 miles require more than $4,000 in maintenance and repair expenses per 25,000 miles, Your Mechanic estimates. And the longer you keep a vehicle, the more expensive the maintenance fees become. For more advice, check out Mic’s guide to buying a car and navigating payments.