How to finance a Car With Bad Credit.
The ins and outs of utilizing credit building loans to finance a car with bad credit. Suffering financial hardships from bankruptcy can bring fresh start auto loan opportunities.
Financial hardship and bankruptcy aren’t the end of your financial opportunity. They can open doors to different financial tools to help you finance a used car: fresh start loans.
What is a Fresh Start Loan?
Financing a car with bad credit is not impossible. Fresh start loans, also known as “credit builder” loans or “new start” auto loans, are a financial product designed for individuals who are having difficulty securing a loan in a more traditional manner. Today, let’s take a look at some of the ins-n-outs of fresh start loans.
It All Starts With Credit
Before we can understand the intricacies of any kind of loan, we have to understand the basics of credit.
According to Experian (one of the three credit reporting bureaus), credit is “the ability to borrow money or access goods or services with the understanding that you'll pay later.” There have been volumes written on this topic, so we’ll just cover the basics.
What Is a Credit Score?
A credit score is a numerical value that represents the “creditworthiness” of a given individual. In short, credit scores reflect how “safe” lenders feel handing out credit, or money, to borrowers (the person seeking a loan). As we will discuss shortly, your credit score is (unfortunately) not a perfect representation of how responsible you have been with your money. Some of the factors that determine your credit score can be hard to control.
The credit score scale runs from 300-850, the higher the number the better. For example, a person with a credit score of 803 is more likely to be approved for a $15,000 auto loan than a person with a credit score of 478. There are other variables that determine an individual’s likelihood of receiving credit, but credit scores play a significant role.
Types of Credit
We now know what a credit score is - but what can it be used for? There are many different forms that credit can take, but they all fall into one of three categories: revolving, installment, and open.
- Revolving: Revolving accounts, like credit cards, only require you to pay a certain portion of the account each month. The leftover balance rolls over (or revolves) into the next month. These types of accounts are almost always tied to an interest rate that you must pay on the revolved balance, or the balance you didn’t pay. This is likely your most frequent interaction with credit.
- Installment: Installment accounts typically take the form of loans, like auto loans, personal loans, and home mortgages. This type of credit requires the borrower (you) to pay a fixed monthly sum. The exact amount depends on the initial amount borrowed, the interest rate, and the length of the loan.
- Open: This type of credit is different in that the entire sum of the “loan” must be paid off at the end of each month, usually. Unlike either revolving or installment types of credit, open accounts usually do not have an interest rate associated with them. The most common type of open accounts are utility and phone bills.
What Determines My Credit Score?
Most Americans likely know that they have a credit score, but many of them are very confused as to the factors that go into determining that score. According to a CNBC poll, 37% of Americans agree with the statement “I have no idea how my credit score is determined.” Let’s demystify it! For our purposes, we’ll use the metrics by which the FICO score (as previously mentioned) is calculated.
- Payment history (35%): The largest slice of the credit-determining pie is based on your past payment history. Lenders like to see individuals that make timely payments and keep late payments to an absolute minimum. Regardless of the size of the credit issued, late payments are problematic. Thankfully, a late payment is not legally required to be reported to credit bureaus until the payment is 30 days past due
- Amount owed (30%): Slightly less weighted is the sum total of your current debts. Having existing debt isn’t a problem (the average homeowner has $202,000 in mortgage debt), but it can signal to lenders that an individual may be taking on so much debt, they won’t be able to pay it back.
- Length of credit history (15%): Generally, lenders like to see borrowers who have been responsibly using credit for longer amounts of time. This doesn’t mean that younger borrowers can’t have good credit scores, but 40 years of responsible credit use is much more convincing than two years.
- Credit mix (10%): Borrowers like to see a variety of types of credit being utilized. For example, let’s look at two different individuals. The first has 3 accounts, they are all personal loans totaling to $5,000. The second individual has 3 accounts: an auto loan, a personal loan, and a credit card. This person’s debts total $5,000 as well. Credit bureaus would look more favorably on the second individual, as they have a more diverse mix of credit types.
- New credit (10%): Last, there is evidence that new accounts are damaging to your credit score. Try to avoid opening up several different, new accounts all at the same time.
Interested in learning more about your credit score? Take a look at the snapshot of the History of the Credit Score! [link to scroll down to snapshot]
Traditional Auto Loan
Before we dive into the details of a fresh start loan, let’s refresh on the basics of how most installment (fixed monthly payment) auto loans operate.
- Principle: This is the amount of money that the loan will be for. It can range from 100% of the cost of the vehicle to anything less. Keep in mind that the sticker price of the car does NOT include fees, taxes, or other costs.
- Interest rate: This is the rate that the lender will charge you to borrow the principle ie: borrow their money. Pay special attention to how often the interest is “assessed.” In simple math, a 10% interest rate assessed once a year on a $1,000 loan would come out to $100. If that interest is assessed more than once a year, the amount of interest paid could be much higher.
- APR: The annual percentage rate is the great equalizer of interest rates. Regardless of whether the loan you’re looking at charges interest once per year or once per month, the APR combines them all into one, single, yearly interest rate. This is very useful in comparing rates amongst different lenders. Individuals with better (higher) credit scores will be capable of securing lower interest rates (paying less). This is because lenders view them as “safer” individuals to lend to, thus they don’t feel the necessity to hedge their bets as much.
- Term: Also known as the maturity date, this tells you the length of time you have to pay the principle (total amount plus interest) back to the lender. A common term for auto loans is 60 months. Shorter terms (often 36 months) will mean higher monthly payments but less total interest paid. Longer terms will be the opposite.
- Default: Not a good word to have in your auto loan vocabulary! An individual defaults on their auto loan when they fail to pay. Depending on several variables like the severity of default and loan specifics, there are many different consequences. All of them are undesirable.
Fresh Start Loans?
Now we arrive at fresh start loans! Let’s cover all the relevant details of this financial product.
What Is the Purpose Of a Fresh Start Loan?
So, you’ve gone to your local bank and attempted to secure an auto loan, but they say you don’t meet the “credit requirements.” You’ve gone to several different credit unions and they all say practically the same thing. This is where fresh start loans can help.
This type of financial product is created to assist buyers with bad credit and it can go by many names: “poor credit loans,” “express loans,” and “last resort loans,” to name a few. While they all have different names, they reference the same thing, and they all have one thing in common: higher interest rates.
Individuals With Bad Credit
As of March 2020, 16% of Americans have a credit score that is “poor.” Experian defines this having a score of 579 or below. There are many reasons why an individual may have a score that low, and not all of them are within your control. Let’s take a look at the profiles of individuals who may be good fits for fresh start loans. In general, fresh start loans are right for people that are unable to secure lines of credit through other means like a traditional bank or credit union.
- Young credit: People who are just starting out may have little to no credit history. This makes them like magic 8 balls to lenders - there can be a lot of unknowns. If the primary reason that an individual’s score is low is due to lack of history, a co-signer on a loan may be a simple fix.
- Poor credit: Unfortunately, unforeseen events and mistakes happen. Even more unfortunately, these will often be reflected in your credit score. Job loss, economic downturn, medical emergencies, and many other incidents can quickly cause an individual's credit score to plummet. This is why we cannot stress enough the importance of having an emergency fund.
- Overburdened credit: Less often, an individual may need access to another line of credit for an auto loan, but that individual is already on the hook for many other debts. This can make it difficult to secure another loan, even for individuals who have good credit.
Auto Loan in Bankruptcy
Everyone experiences financial hardship, and bankruptcy is a scary lens to look at any financial decision through. We could write a whole article on the intricacies of bankruptcy and auto loans, so let’s just take a look at some of the highlights here.
- You can apply for a car loan while in bankruptcy. Lenders, banks, and courts understand that possessing a car is vital to having an income (and thus getting out of bankruptcy). Fresh start loans are a great way to secure the financing necessary to own a car for income purposes. Therefore, it’s also possible to get a car loan with bad credit.
- Your vehicle can be repossessed. Again, this is a complicated topic. Simply put, depending on the type of bankruptcy, the lender of your car loan can request the right to repossess (repo) your car. There are many legal ways to avoid this and many bankruptcy attorneys offer a free initial consultation and can advise you. Important to note: if you are in default on your car loan before filing bankruptcy, your lender can repossess your car WITHOUT NOTICE.
- Can you give your car back to the lender in Bankruptcy? In Bankruptcy you may choose to give your car back to your lender if you know you are approved for financing from a new lender for another car. Bankruptcy is a means for an individual to start to get out from “under” massive amounts of debt. This is a complicated process that you file for. Having defaulted on a car loan may be a leading indicator that you should discuss your situation with a financial fiduciary such as a bankruptcy attorney who is charged with looking out for your best interests.
Signs you may want to look into replacing your car with another car and car loan in bankruptcy? You are way behind on your car loan payments and unable to catch up, your car is in terrible condition with too many miles or service issues, your car is not economical on fuel consumption, or your situation has changed where you simply need a different car than what you have.
Qualifying for Fresh Start Loans
Now that we have a better understanding of who may be a good fit for a fresh start loan, let’s look into some of the qualifications that an individual must likely possess.
- Employment: Almost every fresh start loan provider will need to see valid proof of employment. Depending on the servicer, they may require a specific length of time with one continuous employer.
- Income: Along with proof of employment, most lenders will also want to see what your income is. Depending on the loan amount, some lenders may have required minimum incomes.
- Low existing debt: While it is by no means a requirement that you have no other debts, this can help with the approval process.
- Collateral: The vehicle you are purchasing is, in itself, collateral. Financing institutions that service, or give loans technically own (otherwise known as ‘have a lien on’) the vehicles that the loan has purchased. This means that the bank is capable of taking the car back if you do not pay.
Time To Apply
We’ve covered many of the basics! We have discussed who fresh start loans are for, why an individual may need one, and how to go about securing one. The only thing left to do is apply for a fresh car start loan.
A History of the Credit Score
Credit cards have not been around since the dawn of time, obviously. So, how did Americans get to the point of having so many different credit options? Let’s take a brief look at the timeline of consumer credit in the United States.
- 1908: The Model T premieres in the United States. It retailed for $850 (about $24,000 in 2020 dollars). Although this was still a large sum of money for most Americans, it was the first time that the automobile was considered a tangible purpose for the average citizen. Even so, many Americans who may have been able to afford the vehicle over the course of many years were still unable to purchase a Model T. Thus, General Motors Acceptance Company (GMAC) was born. In 1919, an individual was finally able to purchase a new automobile with only a 35% down payment.
- 1930: By this time, the majority of automobiles were being purchased on credit. Many other large appliances had followed suit. The average American could now buy washing machines, dryer, fridges, and furniture utilizing installment loans.
- 1946: In the middle of the 20th century, credit cards were referred to as “charge cards.” Most large stores - Macy’s, Bloomingdale’s, or Neiman Marcus - offered the option to use one of these cards to purchase product. This was rather inconvenient because each store required its own charge card.
- 1950: Diner’s Club premieres the credit card predecessor. This card was different in that it could be used at many different stores that accepted Diner’s Club. These cards were distinct from modern credit cards in that the entire balance was required to be paid off each month.
- 1955: By this point, millions of Americans were using credit in some form or another. This developed the need for “credit reporting.” Agencies that issued credit (banks, stores, etc) wanted to know if lending money to any given individual was a safe bet. Thus, credit reporting agencies were born. Prior to computers, these companies maintained massive files on Americans who used credit. Warehouses were filled with meticulously filed paper statements, newspaper references, and testimonies. Any credit issuer, for a fee, could have access to information that a credit reporting agency had on an individual.
- 1970: The wild west age of credit reporting comes to an end. The Fair Credit Reporting Act is passed, protecting consumers and codifying what credit really means in America.
- 1989: The Fair Iasaac Score, better known as the FICO score, is established (more on this later). It is now used by more than 90% of credit lenders to establish credit worthiness.