If you want to buy a car and have no credit, how do you do it?
In the old days, buying a car with no or bad credit would have been a real problem. But, thanks to the emergence of the sub-prime auto loan industry, people who have poor or no credit can now walk into some dealerships or car lots and drive home with a car.
But to do this, you have to be a smart shopper in order to avoid predatory lenders.
The reality of buying a car with no credit is that it will be expensive. The car may not be the car of your dreams or the latest model, but it will be a viable form of transportation, so you can go to your job or meet other social responsibilities.
There also are pitfalls for people who want to buy a car and have a bad credit history. Unethical lenders operate in this business, so beware of loans with a high annual percentage rate (APR), long terms, and high fees.
Data also found that people with low credit are paying more for their cars. Edmunds found that the average listing price for used vehicles climbed to $21,558 in July 2020.
As a result, the buyers of more expensive cars assumed longer-term loans, some as long as 84 months (seven years), to reduce their monthly payments. In reality, if a buyer bought a used car and had to pay it off over seven years, the total loan cost would quickly cost more than the car, especially when including depreciation.
Still, for people with bad credit who need a car, the best advice is to be realistic. You should shop around for the best terms or research alternative ways to get the money to purchase the vehicle.
How to Buy a Car with No Credit
When you visit a dealer to select a car, one of the dealer’s first tasks will be to check your credit score to determine the terms for your loan. With this score, they can evaluate the all-important annual percentage rate (APR), including the interest rate you will pay over the life of the loan.
FICO scores range from 300 to 850. A minimum FICO score of 740 is considered good, and this should allow you to get a very favorable interest rate. A person with poor credit has a score below 670. A score between 580 and 669 is considered fair, and one between 300 and 579 is insufficient.
These scores come from the three major publicly traded corporations that focus on rating the credit histories of individuals. These companies exist because businesses have always been concerned about customers who do not pay their bills.
While each credit history company uses its methodologies to produce a credit report, they all rely on data from significant consumer lenders that issue credit cards, mortgages and make other loans.
How significant can these differences be over the life of the car loan if you have a low versus a high credit score?
Credit scores determine your creditworthiness, so in a consumer society based on credit card purchases and making large loans, businesses want to feel confident they are lending money to people who can repay their debts.
Studies have found that people with bad credit have a higher accident risk, so they often pay more for car insurance. Bad credit even is used to determine if you can rent an apartment.
FICO scores range from 300 to 850. A minimum FICO score of 740 is considered good, which should allow you to get a favorable interest rate. A person with poor credit has a score below 670. A score between 580 and 669 is considered fair, and one between 300 and 579 is poor.
Credit scores are compiled by the nation’s three credit reporting agencies: Experian, TransUnion, and Equifax. Fair Isaac & Co. then uses his data to create the FICO score. These scores vary slightly from each company, but they are widely accepted to gauge a person’s credit based on specific criteria.
These scores create the following categories of borrower scores:
Super-prime (FICO Scores of 720 or above)
Prime (FICO Scores of 660-719)
Near-prime (FICO Scores of 620-659)
Subprime (FICO Scores of 580-619)
Deep subprime (FICO Scores below 580)
What Comprises a Credit Score?
Credit scores are based on a person’s financial history. These scores rely on five factors: payment history (35%), amounts owed (30%), length of credit history (15%), new credit (10%), and credit mix (10%).
According to Experian, the most important factors that generate your credit score are:
- Payment history. If you pay your bills on time, this raises your credit score. Missing a loan payment raises a red flag among the rating agencies, and that’s why this factor accounts for 35% of your score.
- Length of that history. This factor looks at the average length of time you have had available credit with an issuer. The rating companies like people who have extended credit histories rather than working with people who are beginning to build their credit. The length of your credit history accounts for 15% of your score.
- Amounts owed. This is based on your credit utilization ratio or the percentage of credit you use from your credit limit. This ratio is applied to each of your credit cards. This number accounts for 30% of your total credit score.
- The mix of debt you owe. This includes car loans, credit cards, student loans, mortgages, or other credit products and accounts for 10% of your score.
- New credit account applications. If you are applying for new credit cards or too many people are inquiring about your credit, it can raise a red flag to the agencies. This accounts for 10% of your score.
First-Time Car Buyers Can Drive Home Even With No Credit History
While some people have poor credit, many others have no credit. The Consumer Financial Protection Bureau (CFPB) estimates that there are 45 million Americans who have an insufficient credit history. As a result, they do not have any scores with the three major credit bureaus.
The good news is that if you can get a car loan with no credit history and are responsible enough to meet the payment requirements regularly, it’s a great way to build your credit score.
Buying a car with no credit can be done through car dealerships, credit unions, banks, and online lenders. If you are applying for a loan, it also pays to show that you have made regular, on-time payments. To prove this, bring copies of utility, internet, credit, other bills, pay stubs, or an offer from an employer showing you are working or have a job offer.
To get the loan, you may also be required to make a down payment. According to Edmunds.com, the average car down payment in 2019 was 11.7%. In 2020, buyers of new vehicles were making average down payments of $4,700, while the down payments of used-car buyers were approximately $3,300.
Beware of Predatory Car Loan Lenders
Because people need cars to commute to work, and so many people have poor or no credit, the sub-prime auto financing industry is a huge business.
The problem is that people who are desperate to get a car can also make bad decisions. Some sub-prime lenders work at “walk-in, drive home” or “buy here, pay here” car operations. These businesses make loans to people with bad credit but at a considerable cost.
Some of these lenders can charge exorbitant interest rates, 20% APRs or higher. Getting a 20% APR from one of these lenders can be compared to credit unions that charge people with good credit rates as low as 2.14%.
In one instance, a car buyer with poor credit explained how he went to a sub-prime auto lender and bought a car for $17,000, plus taxes. He put down a $10,000 down payment. To get the car, the subprime lender charged an interest rate of 22.99%. After he received the paperwork in the mail, he discovered that he had agreed to pay $32,000 for a car that was supposed to cost $10,000.
In some cases, predatory lenders give a commission to the car dealer based on the car’s sales price. This provides the dealer with an incentive to raise the price of the vehicle since they get more significant commissions based on the sales price. The higher price also increases the loan terms. This is bad for the buyer but good for the car dealer and finance company.
Worse, some of the sub-prime lenders are also in the collection and car repossessing business. This means they profit from taking people who default on their loans by taking them to court to collect the remainder of the money owed on the loan.
Consider Other Lenders
If you are desperate for a car because you have bad or no credit, you should seriously consider other types of financing from different sources. Save your money, pay cash for a used car, or ask a relative for a loan. It is financially risky to enter into a financing contract with a “walk-in, drive home” dealer.
The reality is that since cars depreciate quickly, your loan will be worth more than the car almost immediately, especially if you are buying a used car. Worse, these monthly payments will be a financial burden for as long as you are committed to the loan agreement.
Even With Bad Credit, Be a Smart Car Purchaser
People with bad or no credit need cars, and the sub-prime auto lending business is willing to fulfill the need. As a result, subprime auto lenders have issued more than $24 billion in loan-backed securities from 2016 to 2021.
As a car buyer with poor or no credit, consider all your options when searching for a vehicle. Look at online lenders, or ask family or friends if they have a used car to sell without going to a bank or private lender.
Don’t let the fact that you have no credit drag you down into a more significant debt situation. Be realistic about your situation, and don’t sign contracts you do not understand.