How to Get a Car Loan with Bad Credit

When you hear "bad credit," you might automatically think of maxed out credit cards or late payments. While these things do lead to bad credit, there are other situations that can cause someone to have a low credit score. If you relate to any of the following profiles, this guide can show you how to get the best possible car loan.

The young adult with no credit history
If you're a young adult, you may have never had a credit card or have only had one for a few years now. This is known as "credit invisibility". While this means you have no debt, which is great, it also means lenders have no easy way of assessing whether you can be trusted to pay back a loan. As a result, you may only be approved for a high interest rate when trying to get an auto loan or you may be required to get a co-signer.

The avid shopper with lots of debt
If you use your credit cards often, don't pay them off monthly and are sitting on a large amount of debt, that's another concern for lenders. Even using more than 20 to 30 percent of your credit can affect your score, and maxing out your cards can cause your score to plummet. Having lots of debt suggests you don't have a lot of income and need to rely on borrowed money - two things that can lead to missed payments.

The person who misses payments or has defaulted on a loan
If you've consistently missed payments or have defaulted on a loan, your credit score will drop. Lenders see these as indications you're not reliable when it comes to paying back borrowed money.

The co-signer who paid the price
Being an authorized user on someone's credit card or serving as a co-signer can be a huge risk. If the other person isn't responsible with his or her credit, it'll lower not only their credit score, but yours, too.

Your credit score is one of the most important factors in determining the rate on your loan because it shows lenders - whether it's a dealership, bank, or credit union - how trustworthy you are with borrowed money. Your score will determine how much money you can borrow and at what interest rate. "Think about it this way: credit is short for 'credibility,'" said Charles Cannon, manager at a BMW dealership in Houston, TX. "It gives a lender a snapshot of your ability to pay people back in a timely manner and [whether] you are purchasing more car than you can afford."

Your credit score is determined by your credit history. There are a few different types of credit scores, but by far, the most widely used is called FICO (short for Fair Isaac Corporation, the firm that invented this scoring system). According to Secrets From An Ex-Banker by Nick Clements, this is because Fannie Mae, Freddie Mac and Ginnie Mae mortgages, which represent more than 90 percent of all purchased mortgages, use the FICO score. Your FICO score is affected by the following factors:

Do you have a history of making payments on-time, or are you usually late? Are there any delinquencies on your record, and if so, how long have they been overdue? Payment history makes up the largest chunk of your credit score. Lenders want to know you have a good record of paying back borrowed money, whether it's a loan or credit. If you've struggled to pay off debt and/or loans, it'll be reflected by a drop in your score. But the good news is you can turn things around fairly quickly — start making payments on time and your credit score will get a boost.

Having a mortgage, other loans and lots of credit card debt means you probably already owe a lot of money, which can make lenders nervous. Depending how much of a monthly bite this takes out of your income, lenders may think you won't have enough money to make your car loan payment. This part of your score also reflects for how close you are to reaching your overall credit limit - the closer you are to maxing out, the lower your score.

How lenders determine the age of your credit varies. Some may take the average age of your open accounts while others may look only at the age of your oldest account. Either way, all lenders are looking for proof you have experience handling borrowed money and a history of timely payments. The longer the credit history, the better the gauge for lenders. If you're getting ready to apply for an auto loan, don't open any new credit or store cards, take out a loan or close older accounts: All of these can pull down your credit score.

There are two types of credit on your report - installments like auto loans, mortgages or student loans that are capped at a set amount each month; and "revolving" credit such as credit cards. In the latter, the amount you owe each month depends on the amount you charge and how quickly you pay it off. Although there is no perfect mix, lenders like to see experience with both types of credit.

This part of your score is based on how often you've applied for loans or credit, which may be seen as a sign that you're down on your luck. Opening several new lines of credit in a short amount of time could put a dent in your score.

Source: FICO

Remember, getting a car loan with bad credit isn't impossible, but the outcome won't be as favorable as if you had good credit. The typical steps for getting an auto loan are the same for all prospective car buyers - apply for a loan, get approved, choose your vehicle - but there are some additional steps you may need to take if you have bad credit. Here's how to get the best possible car loan with a less-than-ideal credit score:

The three common lenders - banks, dealerships and credit unions - still grant loans to people with low credit, depending on their circumstances.

Sometimes there's no way to get around a high interest rate when you have bad credit but you also really do need a car. When this is the case, there are a few things you can do to avoid defaulting and making your credit score worse.