11 November 2020 Concept Car
Life’s unfair – that’s a given. It is even unfairer if you’re applying for a loan.
This is what we see all the time: People with plenty of money on the side not only find it easier to get a car credit. They can also get cheaper deals. Whereas if you’re already tight for cash, you actually need to pay more to get a loan!
Yes, that’s unfortunately how things work. But: you can do something about it.
You don’t need to pay high interest rates forever.
In this article we’ll explain the exact reasons why you’re paying more than you need – and how you can improve your situation.
Ready to start saving money? Then let’s go.
We’re the first to admit that bad credit car loans will never be perfect. They will always be a bit more on the expensive side no matter what. And you may not be able to get the car of your dreams with them either.
However, they are certainly no longer a problem per se. Things were different back in the 70s, 80s and 90s, when bad credit car loans were considered shady to say the least. Most of these loans were built around buy here pay here schemes and worked on an in house financing basis.
In simple terms, this translated to: Extremely high interest rates and predatory terms and conditions.
Since then, however, a lot has changed.
This is because the entire way that bad credit car deals work has changed.
Today, dealers don’t typically extend a loan out of their own pockets. Instead, they will act as a middleman and negotiate a better deal for you with the banks. This works to your advantage, because, to a lender, a dealership with a proven track record and plenty of cars as security constitutes a lower risk.
And so, a dealership can get you better conditions and still make money on the side. This simple insight has revolutionised the car finance market.
Dealers have also stepped up their customer service. Which means the experience of buying a car with them has much improved. On top of that, the cars you can get even with a low credit rating is astounding. Just take a look at our digital showroom!
No, these loans are still not ideal. Yes, you might prefer to get a lower interest rate. But they are often necessary and a lot better than what you might expect.
To understand why bad credit car credit is more expensive than a conventional loan, it helps to understand how they’re calculated.
On the most basic level, the cost of any loan is based on the risk of the lender to lose her money.
Let’s say two drivers are applying for a car loan.
Obviously, driver A has a lower chance of defaulting on her loan. So giving her the credit she wants is a no brainer for the lender.
Customer B is a different affair, however. It’s not as though the lender should not extend finance to driver B under any circumstances. But if they do, their risk of losing all or part of their money is considerably higher.
To reflect this risk, the dealer will make the loan for driver B more expensive.
It obviously also reflects how easy or hard it is for different drivers to get credit. With her credentials, driver A can get a loan anywhere, so she’ll only accept the best possible conditions. Driver B, on the other hand, will have to shop around.
So while different dealers may actually compete to extend credit to one buyer, they may only reluctantly offer finance to another. If you’re in the latter camp, this disparity is at the heart of your predicament.
It can mean a lot of different things. And it is caused by a variety of factors. No two borrowers are ever the same. You can, for example, have a bad credit score and still get a pretty sweet deal. This is because risk is a number resulting from a series of complex calculations.
Let’s break that down a little bit.
Risk is composed of different factors. Each of these factors either raises the risk for the lender and thus makes the loan more expensive. Or it serves to bring the risk down, thereby satisfying the lender and resulting in better terms and conditions.
This may sound trivial. But from our experience, most people with bad credit are not aware of this at all. Most importantly, they fail to understand the positive message this sends:
Even if you can’t improve all of your risk factors, you can usually improve at least a few. And each improvement contributes to a lower risk and, thus, to a cheaper loan.
Let’s take a look at the risk factors in turn to find out how you can go about saving serious money.
This is the most obvious one. The better your credit score, the usual reasoning goes, the better your deal.
Is this really true?
Mostly, yes. Although much maligned, the credit score is a useful tool to quickly gauge the past financial behaviour of an applicant. You may not always like the consequences. But in general, it is a useful tool.
That said, your credit score never tells the whole story. In fact, in terms of assessing the risk of a default, it falls decidedly short. There are better ways of assessing that risk and in itself, the credit score was never designed to evaluate it.
Credit scores are complex. We have written several blogs about them, for example about how to improve your credit score:
This one seems like a no brainer. Strangely, it is rarely mentioned in articles dealing with bad credit car loans.
Debt in itself need not be an issue with car finance. As long as you have a decent and secure job, you can have a lot of debt and still take on a new credit.
However, with each new loan you add to your portfolio, the risk of a default obviously increases.
What’s more, depending on how this debt is structured, extending yet another loan may be even more risky. If you borrow money from different lenders and then can’t pay it back, usually, the earlier lenders are served first. This puts additional strain on new debt negotiations.
We highly recommend against taking on too much debt. If you really do need a car, we usually advise in favour of reducing monthly payments and extending the loan term. This will help in reducing your monthly payload.
What does risk reflect? The fear of the lender that she might loose her money.
As we established, there are different reasons why this risk can be high. Still, a lender can be more than willing to extend credit to you, even if your credit score is low and your existing debt is already high.
This can be the case if you have plenty of financial resources to fall back on. Plenty of cash on the bank will go a long way in putting the mind of any bank manager at ease.
Securities – objects of value that can be sold to generate cash – are also a great way to improve your chances.
Let’s say you take out a £10,000 loan to buy a car. If you have another car, some valuable jewelry and quite a bit of savings on your account, the lender will obviously be more inclined to give you that credit. After all, should anything go wrong, you can still sell off these resources to repay your debt.
If you don’t personally have any securities, you can ask a financially strong friend or relative to step in for you.
This type of loan is called a guarantor loan and it’s very popular with banks.
One of the most typical constellations is a parent acting as a guarantor for their children.
This makes sense, since most young adults don’t have a credit history yet. This makes it next to impossible for a financial institution to estimate their credit risk. In lieu of a gauge, banks will set interest rates at extremely high levels.
Still, in car finance, you rarely see anyone asking for a guarantor. One reason is that being a guarantor is a serious commitment. And if push comes to shove, having to pay up for the financial problems of someone else can destroy friendships or even marriages. So, understandably, most people would rather not act as a backup plan for someone else’s car buying dreams.
This doesn’t mean that it’s impossible, though. And it’s worth trying: If the odds are stacked against you, getting a financially powerful person on board with you can make all the difference between acceptance and rejection.
When discussing interest rates, even experts often forget about one easy way to achieve a reduction:
Offer the dealer a trade-in.
This is perhaps the best way to keep interest rates down. A trade-in works just like a deposit – and a really big one at that. Dealerships are always interested in buying used cars, because they can make huge profits when re-selling them.
Creditkarma gives an example (calculations in Dollar, but they work just the same in Pounds):
“If you want to buy a $25,000 car with no trade-in or down payment, excluding sales tax, your monthly payment on a five-year auto loan with a 5% interest rate would be around $472. But if you got a credit of $7,000 for your trade-in, your monthly payment would drop to about $340. That’s a savings of $132 per month.”
Income is a very important risk factor. You will often find that many people with an excellent credit rating can get away with a lot of debt, because they have a combination of reassuring factors:
A high income is a vital part of the equation. It provides for a stream of fresh cash at the end of each month.
Of course, you’ll still need to make sure not to take on too much debt. But it goes without saying that more cash means less risk and better sleep.
You can make up for a low income by living a frugal lifestyle.
This is how many in the UK can afford a car loan despite high interest rates: They simply save on anything that’s not absolutely necessary. As a result, there is always enough money left at the end of the month to pay for their loans.
Of course, a combination of high income and low spending would be absolutely ideal.
This, however, is rare. How much you spend is usually closely tied to how much you earn. The more money you have, the more you will want to spend it on nice, precious things. And, in a bizarre twist, taking on debt can actually be financially preferable in some cases – such as when buying a house.
If you need a bad credit loan, however, low outgoings are a must. Before setting foot in a dealership, try to slash all unnecessary expenses. This will improve your chances of success and also help to bring down interest rates on that credit.
Job security as a risk factor is somewhat hard to assess. But it’s quite relevant and more and more lenders are trying to take it into consideration.
It’s easy to see, why:
The problem is how to measure job security. This is why, usually, the way to go is to calculate a risk factor for your industry and then to apply that to your overall risk.
If you’re self-employed, this automatically results in a high risk factor. Seasonal work, like gastronomy, also has a high risk factor.
If you’re working in a bank, meanwhile, your chances of success should be higher. (that said, you’ll probably not have to apply for a bad credit car loan.)
The length of the loan term plays a vital role in setting the interest rate of a bad credit car loan.
The longer the loan, the higher most lenders will consider the risk of a default. This does make sense. Let’s take job security, for example. Your job may be pretty stable for the next 3 years. But what about in ten years from now? On a long enough timeline, the risk of losing your job increases significantly for anyone.
This is why you can bring down the cost of a loan by accepting a shorter loan term.
Vice versa, if you need more time to pay off your debt, you will need to pay more, to reflect the higher risk of a default or missed payments.
A deposit is one of the most effective ways of bringing down the interest rate on a car loan.
By putting down some money, you signal to the lender that you are serious about this deal and that you are committed to it 100%. For the lender, the deposit reduces her risk of a full-on default.
A deposit is therefore clearly beneficial for the credit provider. But it is actually also great for your purse.
By paying money up front, you reduce the amount on which to pay interest. Since interest accumulates over time, you can save a lot here.
Let’s say you need a £10,000 car credit. Your APR is on the high end of the spectrum because you have bad credit. You want to pay off the loan in four years.
If you’re not putting down a deposit, your monthly payments come down to £414.23. Total interest paid over the entire loan term accumulates to £9883.04. So you’re paying almost the value of the car in interest!
If you just pay a deposit of a mere £1,000, your monthly payments drop to £372.81. Total interest is now only £8894.88. That’s still a lot, but considerably less than in the first example.
So, by paying £1,000 upfront, you can save £1,000 in the end. That’s a pretty good deal, we feel.
Self-declared car experts love preapproval as a way of reducing your interest rate.
This is what Nerdwallet has to say about the concept:
“Before you go car shopping, make time to get preapproved for an auto loan. In addition to helping you secure the best interest rate possible, preapproval gives you leverage at the dealership and peace of mind about your purchase.”
Pre-approval means securing car finance ahead of buying negotiations at the dealership. Essentially, you can now step into the showroom knowing what you can buy and what your budget is. You won’t have to suffer through interest rate negotiations, because all of that is now behind you.
At least in theory, pre-approval makes buying a car fun again.
Preapproval means applying for a loan with a bank or credit union. And as we all know, THAT process is not a lot of fun. Especially if you’re in need of bad credit car finance. Plus, you’re unlikely to get the best deal that way, either.
As nice as it sounds, preapproval is not a good way to keep interest payments down.
You will sometimes hear the claim that you can get the best deals by buying new. Some even report that buying new is actually cheaper.
Ramith Sethi of ‘I will make you rich’ fame says:
“Sure, a new car costs more. But over the long term, not that much more. And the value — not just monetarily — can be much higher.”
Moneycrashers even make the following remarkable statement:
“This means that if you’re the kind of person who likes to keep a car until the wheels fall off (like me), your cost per year can get so low that the benefit of buying used disappears completely.”
No.
Sethi’s claim is very vague to say the least. Without a definition of what he means when he says that used cars are “not that much cheaper”, his argument is worthless. If you read the full article, he mainly bases his claim on the idea that a used car may need to be repaired more often and doesn’t feel as nice as a new one. Hardly the stuff of genius.
We already talked about the depreciation argument, but from our point of view it’s exactly the other way round: If you can keep the car until the wheels fall off, you’re better off buying it at around the eight to ten year mark and then re-selling it at almost the exact same price later on.
And what about interest rates?
While it is true that interest rates are slightly lower with a new car, this, in itself, is meaningless. After all, the dealer will apply that rate to a much higher purchase price. So, in the end, your monthly instalment will be considerably higher nonetheless.
If you have bad credit, a new car should not even be a consideration.
Improving on any of the previous points will almost certainly improve your chances of getting a fair and affordable loan.
This is how to do it:
Before we go, here’s another piece of advice, courtesy of Investopedia: Interest rates are like prices on Amazon: They change every day. There is even talk of negative interest rates in the media!
This also means that you can get a great deal every day!
So how do you know when the time is right to buy? Simply watch interest rate offers at your local banks. You can get these easily from the Internet. There are also comparison websites allowing you to pit different lenders against each other.
Although dealerships do not need to follow the rates set by the banks, they usually do. After all, most dealership credits are ultimately re-packaged bank loans.
If you’re patient enough and get as much information as possible, you should be able to beat the odds – and get a good interest rate even with bad credit.
11 November 2020 Concept Car
