Do you know your credit score? This three-digit number carries considerable weight throughout your adult life. It can determine whether buying big-ticket items like a car or house is easy or stressful. For many people, this last point is true, as their credit scores may still improve due to periods of financial instability or limited credit history. With options like car loans for bad creditpeople with low credit ratings can buy a vehicle.
So how do you know if you qualify for a bad credit auto loan? What exactly is it, and is it too good to be true? Here’s the inside scoop on credit scores, car financing, and why a bad credit car loan can work in your favor.
Your credit score explained
What is a credit score, other than a three-digit number that can add tremendous stress to any major purchase? Your credit score is a number between 300 and 900 that tells a lender (the bank or institution you borrow money from) how risky it is to give you a loan. The higher your credit score, the lower the risk to the lender as you are likely to repay the debt.
On the other hand, the lower your score, the higher the perceived risk of loan default, or non-payment. If you default, the lender has no choice but to send you for collection, repossess the vehicle, or foreclose on your home.
Credit scores are calculated by major credit bureaus like Equifax and TransUnion. These companies work together to collect data about your financial activity. This data is then categorized into five categories: payment history, credit usage, credit history, credit mix, and credit inquiries. Each of them has a certain weight or influence on your overall score. Here’s what that means:
- Payment history represents 35% of your credit score and looks at how quickly you paid, or if any accounts were cashed.
- Credit usage is 30% of your score and looks at how much credit you are using. Ideally, you should only be using 35% of your available credit, which means not maxing out your credit cards.
- Credit history is 15% of your score and takes into account how long you’ve had lines of credit open. In this case, the longer the better, as it shows a diagram of how you manage your debts.
- The Credit Mix represents 10% of your score and seeks a healthy balance between revolving credit (credit cards) and installment credit (car loans, student loans, mortgages).
- Credit inquiries represent 10% of your credit score. This category looks for frequent and serious inquiries about your score, implying that you are in financial difficulty and need money.
Credit ratings: poor to excellent
Canadian credit scores range between 300 and 900, with 650 as the average score. There is no set standard of a good or excellent credit rating. Instead, each lender sets their requirements for acceptable score. However, there are some general guidelines on what these scores mean. For example, Equifax classifies scores as follows:
- 300 to 559: Bad
- 560 to 659: Fair
- 660 to 724: Good
- 725 to 759: Very good
- 760 to 900: Excellent
Car loans for bad credit: the basics
When you need a reliable vehicle to get to and from work, there’s nothing more stressful than knowing that your credit score will make the purchase almost, if not entirely, impossible. Rebuilding your credit after a period of financial instability is a daunting task and a seemingly endless cycle. You need to rebuild your credit with a new line of credit, but your low credit score is preventing you from getting a credit card or a loan. Without a vehicle, getting to work becomes even more difficult and puts you at risk of losing your job; a stable source of income is essential to pay your bills on time.
Traditional lenders set high requirements or standards, which is fine when your credit score is very good or excellent. However, this makes major purchases virtually impossible for people who are rebuilding their credit or who don’t have a long credit history. This is where car loans for bad credit come in. These loans break the cycle to help people with low credit scores or minimal credit history. How? They defy the standards set by conventional lenders.
Bad credit car loans, commonly known as subprime car loans, do not have the same high standards as conventional car loans. Instead, subprime lenders allow people with low credit scores to purchase a vehicle. So what’s the problem ?
Car loans for bad credit: too good to be true?
Bad auto loans aren’t too good to be true. Although they may look like “bad loans”, they are a workable solution for car buyers with bad credit. People who qualify for these subprime auto loans typically have a high debt-to-equity ratio and a credit score below 600. They may also have a history of bankruptcy, foreclosures, frequent late payments, or lines of credit sent to collections. – or little credit history at all.
Subprime lenders consider these characteristics for each potential borrower. In exchange for lower standards, a car loan for bad credit usually comes with a higher interest rate and fees. The higher interest rate reflects the higher risk the lender takes when making the loan. It is quite possible that the loan will not be repaid, which could result in a significant financial loss for the lender. Additionally, a lender may charge a penalty fee for repaying the loan before the end of the term or contract.
When shopping for a bad car loan, one of the most critical questions to ask is whether the lender is reporting your payments to the major credit bureaus. Why is this important? Subprime lenders are not required to report your payment activity. If you work with a lender who doesn’t report your payments, your lending activity isn’t helping to rebuild your credit, and that means every payment you make — on time and in full — isn’t always benefiting you. . way. On the other hand, if your lender reports your payments, this activity can have a positive impact on your credit score.
Your future behind the wheel
One of the biggest takeaways is to understand that not all bad credit auto loans are equal or beneficial. For example, if your goal is to rebuild your credit, working with a subprime lender that doesn’t report to the major credit bureaus is a waste of time. Unfortunately, the market is also fraught with predatory lenders known to withhold essential information and charge exorbitant fees. While regulation has mitigated many of these practices, it’s still important to put safety first: work with a reputable lender, ask lots of questions, and read the fine print more than once.
Ultimately, a loan of any type, whether it’s a bad credit car loan, credit card, or mortgage, is a contract between you (the borrower) and the lender. As with any contract, it is essential to understand the terms and read the fine print before signing on the dotted line. For example, in the case of a car loan with bad credit, make sure the contract describes everything in detail: the duration of the loan, mandatory monthly payments, interest rate and associated fees. Then it won’t be about what’s expected of you, setting you up for greater financial success as you rebuild your credit, one payment at a time.