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Car Loans for High Risk Borrowers

Buying a car is one of the more difficult purchases consumers can make; it is also one of the largest purchases on a person’s life. Being that it is such a costly expenditure, consumers would benefit from careful consideration and planning before making a decision.

When buying a car, it can be all too easy to make an emotional decision in the show room, looking at the flashiest new models in all the latest trendy colors, with the newest, updated features. There are countless advertisements running enticing consumers to take advantage of the low prices and ideal financing terms. The reality is that financing an automobile is expensive, relative to other purchases, based on interest rates. Additionally, for consumers with bad credit, an auto loan can be a very expensive financial decision.

Interest Rates

Like other financial products, the interest rates for car loans are much higher for consumers with bad credit. Additionally, the terms of the loan will affect the interest rates. Auto loans typically have terms of 36, 48 or 60 months. The shorter term loans have the lower interest rates; alternately, the longer term loans have higher interest rates. Similar to other loan products, the credit score of the borrower determines the interest rate for the consumer. Consumers with good credit enjoy lower priced loans than those with bad credit.

Loan rates are also different for new and used cars. Consumers can typically obtain lower cost financing on new car loans. However, the interest rates are higher for used cars. For example, an advertised interest rate schedule offered a rate for a new car at 3.18 percent and a 3.94 percent rate for used car, both for a 36-month loan.

The following tables show the variation in interest rates for excellent to very bad credit scores for 36, 48, and 60-year loan terms for new car loans.

$25,000 Loan with a 36-Month Term

Credit Score Rate* Payment Variance Interest Paid Variance
Excellent 3.682% $735 - $1,444 -
Very Good 5.103% $750 $15 $2,015 $571
Good 7.275% $775 $40 $2,903 $1,459
Fair 10.999% $818 $83 $4,464 $3,020
Poor 16.026% $879 $144 $6,653 $5,209
Very Bad 17.167% $893 $158 $7,162 $5,718

*Hypothetical rates

In the above table, the interest rate for a $25,000, 3-year loan for the purchase of a new car for an excellent credit is 3.682 percent. This equates to a monthly payment of $735 a month and totals $1,444 in interest payments for the life of the loan. Contrast that scenario to the very bad credit. The consumer with very bad credit will pay 17.167 percent for the same 3-year loan, which equates to a monthly payment of $893 and a total of $7,162 in interest over the life of the loan. The consumer with very bad credit would pay $5,718 more for the same product.

$25,000 Loan with a 48-Month Term

Credit Score Rate* Payment Variance Interest Paid Variance
Excellent 3.83% $563 - $2,005 -
Very Good 5.31% $579 $16 $2,805 $800
Good 7.57% $605 $42 $4,055 $2,050
Fair 11.45% $652 $89 $6,277 $4,272
Poor 16.68% $717 $154 $9,428 $7,423
Very Bad 17.87% $732 $169 $10,168 $8,163

*Hypothetical rates

Interest rates for the longer term loan, in the above table the figures are for a 48-month term, are slightly higher than the 36-month loan. The consumer with excellent credit will pay 3.83 percent compared to 3.68 percent, a difference that amounts to $561 in interest. The consumer with very bad credit will pay an additional $3,006 for the 48-month loan, for the opportunity to have lower monthly payments.

$25,000 Loan with a 60-Month Term

Credit Score Rate* Payment Variance Interest Paid Variance
Excellent 3.99% $460 - $2,617 -
Very Good 5.53% $478 $18 $3,672 $1,055
Good 7.88% $506 $46 $5,230 $2,613
Fair 11.92% $555 $95 $8,304 $5,687
Poor 17.36% $626 $166 $12,572 $9,955
Very Bad 18.60% $643 $183 $13,581 $10,964

*Hypothetical rates

Interest rates for the60-month term are higher than the 48-month term loans, and the monthly payments are much lower, which might be a more appealing option for borrowers. For the excellent credit, the monthly payments are $460, $275 lower than the 36-month term loan. The interest payments over the life of the 60-month loan total $2,617, $1,173 more than the 36-month term. Consumers with very bad credit will have monthly payments of $643 a month and pay a total of $13,964 in interest over the life of the loan, almost $11,000 more than the consumer with excellent credit. That exceeds 400 percent of the excellent credit’s payment. As these examples demonstrate, financing an auto with bad credit is very expensive.

Interest rates for used cars are even higher than new car loans. Consumers should shop around and compare the loan rates at banks, credit unions, and online lenders, to what the dealer is offering. When consumers arm themselves with information, they have more leverage in negotiating with dealers to get the best price for the car and better financing options. Alternately, consumers may consider buying an older model vehicle and paying cash to avoid high interest rate loans. Another financial advantage is lower insurance premiums on a less expensive vehicle, which can be beneficial for consumers working to repair their credit. Auto insurance is also priced based on the consumer’s credit score. Negotiating the value of a trade-in is also important to get the lowest price for the new car. Visit the Federal Trade Commission site http://www.ftc.gov/bcp/edu/pubs/consumer/autos/aut11.shtm for more helpful tips.

Auto Loan Scams

Consumers with bad credit, who do not understand their own credit situation or their rights, can be vulnerable to unscrupulous lenders who manipulate unwary borrowers. Consumers should always know their rights and be familiar with their credit reports and credit score. They can obtain free copies of their credit reports annually from www.annualcreditreport.com. Unfair or illegal lending practices include deceiving borrowers by convincing them that their credit score is lower than it may actually be, and that they could not qualify for a better rate. It pays to know understand the various tactics sellers may use to try to manipulate unwary buyers. It’s even more helpful for consumers to do their research and be familiar with their own credit profile.

Some lending scams claim that anyone can be approved for a loan with proof of employment and a minimum monthly income, and no credit check. Other offers include used car deals giving buyers with bad credit zero percent financing for the first year. If it sounds too good to be true, it probably is. The lender will charge exorbitant rates in the following years, often higher than the borrower can afford. Consumers should always read the fine print, ask many questions, and walk away if it sounds less like it might not be a legitimate business deal.

Be Prepared

Before visiting the dealership, consumers can do their research online. They can research car prices and interest rates and have more power in negotiating. Consumers can also secure financing before they get to the dealership to ensure they have the best deal.

It is also a great idea for consumers to shop for cars when they can get the best deals. For example, at month-end and year-end dealers are pushing to meet their sales quotas. Buyers have more leverage knowing the dealer needs to make the sale to meet their numbers.

The best scenario for consumers with bad credit would be to clean up their credit before buying and financing a new or used car. It is much less expensive to finance an auto loan for the shortest term possible with the highest credit score. It is worth the effort for consumers to improve their credit situation.

Consumer Rights

Consumers are protected under federal law, including the Truth in Lending Act, Equal Credit Opportunity Act, and the Fair Credit Reporting Act. Visit the http://www.ftc.gov/bcp/edu/pubs/consumer/autos/aut04.shtm for more information and for contact details.

 


 

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