How To Get An Auto Loan With Bad Credit

How to Get a Car Loan with No Credit

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Getting a new car (or just new to you) can be exciting, but it also brings some pressure if you don't have the funds to pay for the car outright — and most people don't. Of course, financing options are plentiful for vehicle purchases for people with great credit histories, but those options start disappearing quickly if you don't have a solid credit history to back up your promise to pay. Some people ask family members or friends to co-sign auto loans for them, but others aren't comfortable with this approach and prefer to build credit on their own.

The process for obtaining a car loan on your own with no credit is more challenging, but it isn't a lost cause. You could start by taking steps to build a credit history before purchasing — applying for a credit card with good approval odds, for example — but if you need to purchase a car soon, then you won't have time to wait on that approach. Fortunately, whether you're a young first-time borrower or a seasoned consumer who paid for purchases in cash in the past, you can increase your approval odds by following some basic tips. Here's what you need to know about getting a car loan with no credit.

Check Your Credit Score: No Score vs. Low Score

In the U.S., three main credit bureaus — Equifax, TransUnion and Experian — gather and store credit history information on consumers. If you have never borrowed money from a lender or opened a credit card or other type of credit account, then you shouldn't have a documented credit history with any of the credit bureaus, which results in no credit score (zero scores do not exist). It's also possible to have no score if you haven't used credit in many years. Most negative credit information is removed from reports after seven years, but even good accounts are removed after they don't have any activity for 10 years, which results in credit bureaus no longer producing a credit score.

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One important thing to remember is that having a low credit score is not the same thing as having no credit history, and lenders will treat these situations differently. If you have used credit before and had issues that damaged your score, you will need to review tips for getting a car loan with bad credit, as some of the advice will be different. You can request your credit report and score online via the bureaus' websites or use one of several services, such as Credit Karma, to view your information online.

Be Prepared to Prove the Details on Your Application

Once you've confirmed that you don't have a credit history or credit score with any of the credit bureaus, then you can focus on ways to solve this problem. In most cases, both prime (good credit) and subprime (bad credit) lenders automatically resort to using credit scores to assess the likelihood that applicants will be able to pay their mandatory monthly loan installments. That means you can probably expect your loan request to be initially declined, but that decision isn't always final.

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Without a credit score to back you up, you need to be prepared to offer alternative evidence and information that supports your ability to make payments. If a car dealership submitted your loan application, then a loan expert in the finance department will contact the lenders for you to try to negotiate an approval by offering relevant documentation about your finances, such as proof of income, bank statements, rental payment history, utility payment history and any unreported payment histories — furniture leases, etc., that weren't reported to credit bureaus. If you applied directly to a bank or finance company, you will need to contact the loan officer yourself to discuss approving your loan based on supporting documentation.

Improve Your Odds: Income Documentation

If you want to convince a lender that you are a worthy credit risk without a credit file and score to back you up, then you need to provide as much information as possible to support your ability to pay. In terms of income, the more you make, the better, but the actual amount required to qualify depends on a calculation known as debt-to-income (DTI). This calculation takes your total debt payments each month — including rent and the potential car loan payment — and divides the amount by your total gross income. The acceptable DTI percentage varies a great deal among lenders and could be as high as 40% to 50% in some cases but is often somewhere around 36% for prime lenders.

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For auto loans, many lenders use the payment-to-income (PTI) percentage instead of DTI. This calculation divides the estimated payment (plus car insurance) by your total income. Most lenders decline loans when this percentage exceeds 15% to 20%, although this also varies among lenders. Ideally, you want to meet the approval standards for both of these calculations to increase your chance of success.

If you go to a dealership in person, take relevant income documentation with you. Paycheck stubs covering at least a two-month period are one of the best ways to prove your income is steady and reliable. If you decide to use income tax returns instead of pay stubs, then provide multiple years (if possible) to show the steady continuity of your income. Bank statements can also provide proof of your typical income and cash flow.

Improve Your Odds: Price and Down Payment

It can be very tempting — especially when buying your first vehicle — to let all those new cars lined up at a dealership mesmerize you with their shiny appeal. If you want to increase your odds of approval, you need to fight the urge to pick a flashy, expensive car. Lenders will be much more willing to give you a chance on your first car loan if you choose a modest used car in a reasonable price range — or at least a very reasonably priced, economy-class new car.

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You've probably seen plenty of TV ads for new cars with no down payments and no (or low) interest rates. That won't apply to your situation, and your best chance of success includes agreeing to make a substantial down payment on the vehicle you want to purchase. According to Edmunds, the historical standard for a down payment was once 20%, but rising car prices in the last decade have brought that number down. As someone applying for a car loan without credit, you could gain substantial bargaining ground if you offer a 20% down payment.

At the very least, you should expect to be asked for a sizable down payment, even if the percentage is much lower, but large down payments do come with some benefits. It may be difficult to convince a lender to give you their best interest rate, so a smaller loan amount adds up to smaller monthly payments and much less interest paid over the life of the loan.

Improve Your Odds: Special Programs

One of the best ways to improve your odds of approval for a car loan is to look for dealerships that offer special programs for first-time buyers. These programs often focus on college students or recent graduates — college or even high school — but it's possible to find other types of first-time buyer programs as well. These programs are specifically designed to help buyers who wouldn't qualify for loans in traditional ways. They still include specific qualifying criteria, but it may be easier for applicants to meet the requirements. Examples of these qualifying factors include a good GPA, a large down payment and a limited loan amount.

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What to Avoid: Buy Here, Pay Here Financing

Some car dealerships lure customers in with tempting offers of no credit checks and approvals for every buyer. The main problem is this type of financing almost always comes with interest rates that could climb as high as the state maximum, which could be 20% APR or more. Some of the other terms could be questionable as well. To add insult to injury, these dealerships don't usually report your payments to the credit bureaus, which means you pay an outrageous amount for your car and still don't build any credit history.

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Beyond the Dealership: Alternative First-Time Financing Options

When it comes to approving borrowers for their first loans — auto, mortgage and otherwise — some financing sources have a reputation for being more open to newcomers than others. Credit unions and smaller local banks (versus giant national banks) have long been recognized as valuable sources of loans for those who are challenged by no credit, minimal credit or even poor credit situations. This is especially true if you already have an existing relationship with the bank or credit union. Some online lenders also specialize in car loans for buyers with no credit, but any online lender should be thoroughly researched before applying.

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If all else fails, borrowing the money from family is a tried-and-true option for many buyers, even those who have had car loans before. The pitfalls of this option are obvious, so if you go this route, it's best to write up and sign a firm agreement that outlines all the details of the loan and its repayment terms to avoid future misunderstandings that could cause a family rift. You also don't build a credit history with this type of loan, but you just might get an interest rate that would be impossible to beat.