You really need to buy a new vehicle, but your credit scores aren’t up to standard. Don’t panic. Your lower scores don’t have to prevent you from purchasing a new car. Have you considered applying for a subprime auto loan? These are available for those who have low credit scores. Credit scores between 501 and 619 are generally regarded as subprime.
Before applying for a subprime auto loan, learn more about its terms and the consequences of default.
What Are Subprime Auto Loans?
A subprime auto loan, sometimes called a second chance auto loan, can be used to finance a new car purchase for those with poor credit scores or little or no credit history. Because borrowers with poor credit are more likely to default on their payments, these loans carry steeper interest rates than their traditional counterparts. The lender may also charge a prepayment fine if you decide to pay the loan off before the due date.
Do your research before applying for a subprime loan. Each lender has a different set of criteria and different fee structures. It’s also a good idea to try to improve your credit score before looking for financing for your vehicle. Doing so may make you a candidate for a loan with better terms.
How To Improve Your Credit Score
Lenders calculate your credit score from the information in your credit report and history. It provides a record of your financial history and how reliable you’ve been in paying off previous debts. This information allows them to determine whether likely to honor your payments or default. If your previous payments have been consistent and on time, then your credit score will be higher than that of borrowers who have paid late or missed payments.
Here are some practical ways to improve your credit score.
- Always pay your installments on time. Arrange for automatic withdrawals from your checking account to prevent late payments.
- Don’t max out your credit cards. By only spending a third or less of your credit limit, you can increase your score. It’s best not to close old credit card accounts, even if they’re not in use. Having accounts in your name that are not in arrears can improve your credit score.
- Check your credit reports on a regular basis and query anything that looks incorrect to keep your records in good standing.
How Your Financial Situation Impacts Subprime Loan Amounts
When applying for subprime loans, lenders look at your credit score, your payment trends, your current expenses, your possible future expenses, and your employment circumstances. Your debt to income (DTI) ratio shows the effects of your debts on your income. This factor has a huge impact on your application for a subprime loan. Any DTI that is more than 50% will negatively affect the lender’s offer.
The lender also considers your payment to income (PTI) ratio. This factor measures how much of your income goes toward the vehicle payment and insurance. If this number is over 20%, you might not qualify for the loan.
Think beyond the monthly payment, and work out the total amount of financing and maintaining the car you want to buy. If you decide to increase the term of your loan from 48 months to 60 months, for example, you’ll end up forking out more for interest. Don’t forget about the maintenance of the vehicle and repair work that may be needed from time to time. You should also take your car insurance payments, weekly gas bills, and charges for wear and tear into account when calculating the monthly payment you’re able to make.
The Pros and Cons of Subprime Auto Loans
One of the advantages of subprime loans is that they’re easier to qualify for than other loans. There are even cases of subprime lenders who haven’t correctly followed procedures and aren’t concerned about your credit score. As long as you are employed, you should qualify for a loan, even if you’ve defaulted on previous loans.
The disadvantage of subprime loans is their high costs. Higher interest rates, a loan origination fee, and prepayment penalties make them much more expensive than traditional loans. With higher car payments, subprime borrowers can fall deeper into debt. These loans may be convenient but carry hidden costs.
Risks of Subprime Auto Loans
As convenient as it is to apply for a subprime loan, you need to be aware of the potential risks.
High Interest Rates and Fees
Subprime auto loans generally have a higher annual percentage rate (APR) and higher fees than traditional auto loans. The APR is the annual rate of interest and severely alters the actual cost of your vehicle.
Risk of Default and Repossession
When a borrower ties into a subprime auto loan with a repayment plan that is difficult to stick to, there’s a strong possibility of defaulting on the loan. This can result in having the car repossessed. If there was a co-applicant in the agreement, that person becomes responsible to repay the loan in the case of non-payment by the borrower. Defaulting on a subprime loan can have financial repercussions that will be felt for years to come.
Work Around Subprime Auto Loans
If you have no alternative, you can mitigate the financial burden of taking out a subprime auto loan by doing the following:
- Assess your credit report
- Calculate all costs
- Postpone buying a new car
- Consider buying a less expensive or certified pre-owned vehicle instead of a new car
- Weigh the terms
- Draw up a budget
- Work with your bank
- Research loan options
It’s important to know what you’re taking on before signing for a subprime auto loan, both the benefits and the risks. Make sure that you are able to afford the monthly payments and the other vehicle- and loan-related expenses. If you believe that you’re capable of making the payments on time and maintaining a new vehicle and if there is no other loan you can apply for, then consider a subprime auto loan.
At FIXD, our mission is to make car ownership as simple, easy, and affordable as possible. Our research team utilizes the latest automotive data and insights to create tools and resources that help drivers get peace of mind and save money over the life of their car.