Every big vehicle loan you’re likely to make in your life is influenced by your credit score. The most important is your home, followed by your car. For better or worse, many of us can’t see a future without a car these days, so it’s important to know all the facts before making any big purchases. Bad credit vehicle loans certainly exist, but like any big financial choice, knowledge, and it’s prudent to arm yourself as much as possible before entering the fray.
The unfortunate reality is that if your credit history is below optimal (whether or not this is your fault) you will pay extra cost on your bad credit auto loan. It makes perfect sense if you consider the scenario from the lender’s perspective.
Your credit score is made up of a slew of pieces of information. Your history of handling financial obligations is the most heavily regarded among it for the algorithm that calculates the score. It all boils down to how trustworthy you are—and how trustworthy you have been—whether it’s paying your television, phone, electric, and utility bills, or repaying loans you’ve taken out to buy anything from a new stereo system to an entire house. Read the vehicle loan agreement to ensure the terms and conditions.
How Interest Is Calculated
You don’t want to provide money to those who aren’t going to pay that back if you’re a loan. That’s just basic math: you give the money away and expect it back eventually. And if you’re trying to find out if someone is likely to pay back a loan, whether that’s a bad credit auto mortgage or indeed any loan at all, it makes sense to start with the buyer’s credit file.
So, as a lender, how do you mitigate the risk of loan money towards someone you don’t know if they’ll pay it back on time and in full?
Interest rates are the answer. Interest rates, as we all know, are extra amounts of money determined as a percentage of total mortgage and included in the full loan arrangement to shield the lender from every risk they may be taking on by acquiring the loan in the first place. Auto loans for people with bad credit are no more unique than every type of loan.
The lender will defend himself against the risk posed by a buyer with a bad credit score by boosting the interest rates correspondingly. More risk means more interest paid, but purchasers with great credit scores don’t present a risk and are therefore charged lower interest rates. It’s an ugly aspect of the process, but it’s ubiquitous, and no matter where you go to try to get a bad credit auto loan, you’ll run against the same mentality.
How Do Interest Rates Affect Your Credit Score?
This is the same rationale that shows why used car interest rates are much higher than new model interest rates. Used cars reduce the risk for the person or people selling them, therefore interest rates are higher to adjust for that risk.
The interest rates imposed by auto lenders were shaped by a range of factors. While your credit score is the most important factor, companies still consider things like the duration of a loan, the year and usage of the vehicle, your gender and age, or where you are living. Now onto the heart of the matter now that we do have a working understanding of how interest rates vary based on the lender’s possible risk.
If you have a bad credit score, what more extra can we pay on your car payment?
To answer that topic, we must first explore how purchasers are classified depending on their credit ratings.
Buyers of Different Types
There are five separate buyer levels, and your score will determine which of the five groups you fall into.
- Deep Subprime is the weakest and riskiest of these categories, covering all buyers with credit ratings between 300 and 500.
- Subprime follows, with a score ranging from 501 to 600. This is considered as a bad credit history.
- Non Prime refers to purchasers with a credit score of 601 to 660, which falls in the middle of the five tiers. Non Prime purchasers may be thought of as neutral: their credit score isn’t great, but it’s also not bad, and they can expect to pay dead-middle interest rates.
- Prime (a credit score of 661–780) and Super Prime (a credit score of 781–850) are considered good credit ratings. Due to the fact that they provide essentially no risk to the lender, these customers will receive the best interest rates available.
Durations of Loans
Higher interest rates are also related to the life of the loan. The shorter the length of the loan, the larger the interest rate. When you’re curious, here’s the formula they then used to work it out. If at all feasible, avoid falling into the same trap of believing that lengthier loans are now more attractive because of the smaller monthly bills you’ll have to make. Sure, this could look good on the piece of paper in front of you that details all terms of your bad credit vehicle loan. Don’t be deceived, though.
You’ll pay a lot more in the long run since you’ll be making payments (at higher rates, according to the conditions of the bad credit car loan deal) for a longer period of time. Remember this interest is not included in the numeric value of the car you’re trying to purchase; it’s a percent added on to compensate for the lender’s risk. The longer you pay interest, the more money you’ll have to pay to account for the lender’s risk. The interest on all loans does not go toward the purchase cost, and poor credit car loans are no exception.
It’s time to crunch some numbers
To further drive this argument home, let’s look at some numbers. The average new car loan interest rate for Super Prime purchasers was 3.23 percent in 2018, according to Experian’s State Of The Car Market report, and the average used car loan interest rate was 3.95 percent.
We’ll see how that stacks up against said categories
- For new and used car loans, prime buyers received average interest rates of 4.16 percent and 5.68 percent, respectively. Consumers who aren’t prime received 7.05 percent and 10.44 percent, correspondingly. Have you observed how quickly your interest obligation is rising? We’re just halfway through the list so far. Then there’s the harsh reality of those of us with bad credit who are searching for bad credit car loans.
- On new cars, subprime purchasers received an average interest rate of 11.35 percent, while on used cars, it was 16.92 percent. Consumers in the Deep Subprime category (those with a credit score of 300 to 500, to be clear) had an average new automobile lending rate of 14.07 percent, while the average used car loan interest was a frightening 19.81 %.
- Take a second to reread that graph. The interest rate on a secondhand automobile is 19.81 percent. Let’s face it: if your credit score is between 300 and 500, you’ll have a hard time saving enough money to purchase a car outright, much like you’ll have trouble buying a new automobile.
- As a result, Deep Subprime purchasers can expect a terrible credit auto loan to bind them to a near 20% interest obligation! Just to smooth off the risk for the individual who gets you the bad credit vehicle loan, you’ll have to pay a fifth of the entire amount of the loan. One among the total costs is not allocated to vehicle financing.
