Getting an auto loan with bad credit
If you have poor credit, there are two basic choices when it comes to getting an auto loan. You can either get a subprime loan from the car dealer, or get a loan from a bank or credit card with compensating factors.
If you go the dealer route, expect to pay an interest rate in excess of 20%. They can usually get financing for scores of 580 and above, but if you’re below it’s probably a 50-50 chance you’ll be approved.
A better option may be to check out a loan matching service, like Fiona. By filling out a one-page application, you can get the best offers from various lenders who are competing for your business. If you have bad credit, you’ll see high interest rates. But at least it will give you an opportunity to take advantage of the lowest rates available. It’s likely to be a better deal than dealer financing.
If you apply at a bank or credit union, you’ll get a much better interest rate. But to do it, you’ll have to get a cosigner with strong credit. Banks and credit unions generally prefer credit scores of at least 650. Your cosigner should be at least at that level, and preferably higher.
They may also require a down payment of between 10% and 20% of the purchase price, as well as approve a smaller loan then you hope to get.
Getting a mortgage with bad credit
Prior to the Financial Meltdown of 2008 it was possible to get a mortgage with poor credit. But this was done through subprime mortgages, which are no longer commonly available. That’s not a bad thing either. Subprime loans usually required down payments of 20% or more, came with high interest rates, had a two-year fixed payment, then adjusted every six months thereafter, and charged a fat penalty if you tried to pay off the loan within the first two or three years.
As a result of that debacle, the mortgage industry has tightened credit standards. As a general rule, lenders won’t make loans to borrowers whose credit scores are below 620. And even if you are a little above 620, you’ll pay a higher interest rate.
Even now, some mortgage lenders will approve an FHA mortgage with a credit score as low as 580.
But 580 to 620 is in the “fair” credit category. If you have bad credit, your credit score is below 580.
If it is, your best option is to try an FHA mortgage with a 10% down payment. FHA loans normally require 3.5% down. But with a higher down payment, they may accept a credit score below 580. Best of all, the entire 10% down payment can be a gift from a family member.
Complications of the FHA 10% down strategy
There are some complications with that strategy:
- Not all lenders will offer that type of arrangement. Most won’t go below 580, even on an FHA loan. You’ll have to do some serious research to find a lender who will.
- The reason for the low credit score will matter. For example, if your credit score is 525, because you had foreclosure two years ago, you probably won’t get the loan. The same is true if you had a bankruptcy within the past year.
- The reason for the bad credit will have to be “extenuating circumstances”. That can include a divorce, a serious illness, or some other event of that magnitude. You’ll need to provide documentation supporting your claim.
- All other aspects of your loan application – income, job stability, and debt ratios – will need to be well within acceptable limits.
Salvation on the refinance front
It may be easier to get a mortgage for a refinance than for a purchase, even if you have poor credit. There are three programs you may be interested in if you need a refinance.
This is a government refinance program for conventional mortgages. To be eligible, you must meet the following criteria:
- Your mortgage must be held by either Fannie Mae or Freddie Mac.
- It must have been originated and closed before May 31, 2009
- You haven’t used the HARP option in the past.
- You’re “upside down” on your home – meaning either the property has declined in value, you owe more on the property than it’s worth, or you have very little equity.
- You can have no more than one 30-day late on your mortgage within the past 12 months, and none in the past six months.
FHA Streamline Refinance
This is a simplified refinance program strictly for existing FHA mortgages. The loan offers reduced documentation, and on the credit side, requires only that your existing mortgage be current (all payments made up to date).
VA Interest Rate Reduction Refinance Loan (IRRRL)
If you’re an eligible veteran, and you’re looking to refinance a VA mortgage, you can use this program to do it, even if you have bad credit.
These refinance programs are available through most mortgage lenders.
Solutions for people with bad credit
Earnin lets you get access to your paycheck before payday actually rolls around. But that’s not the only good news – Earnin is completely free!
You can get access to up to $100 per day and the next time you get paid, Earnin will automatically deduct the amount borrowed from your paycheck. There’s no interest to worry about, and you can pay whatever fee you think is fair.
You can also set an overdraft alert that lets you know when you’ve gone below a certain amount in your bank account.
Though we suggested using cosigners in different situations, it’s not always an option when you have poor credit. But if it is, tread lightly.
Your performance on a cosigned loan will directly affect your cosigner. If you make any late payments, they show up as late payments on your cosigner’s credit report as well. And if you default on the loan, the lender will move against your cosigner for payment. It’s an excellent way to ruin a good relationship.
Borrowing from family and friends
Use this option only in an emergency situation. It’s bad enough if you have late payments or if you default on a third-party loan. But if you do it with a personal loan from family or friends, it can permanently destroy your relationship.
What is considered bad credit?
There are five levels of credit – Exceptional, Very Good, Good, Fair and Very Poor. According to Experian – one of the three major credit bureaus – bad credit is a credit score below 580.
Unlike good and fair credit, there’s not much wiggle room when it comes to bad credit. Not only is 580 a pretty strong dividing line, but some lenders will even lump those with scores between 581 and 620 in the bad category. However, since we included the 581 to 620 band in Borrowing When You Have Fair Credit, we’re going to focus on those with credit scores below 580 in this article.
bad credit drill down – what makes it up
One of the basic problems with a credit score below 580 is that it’s usually the result of either a very serious credit issue, or a series of smaller ones.
A bankruptcy or foreclosure within the past two years could certainly make it happen. So could a tax lien. If any of those situations is the major reason for your low credit score, you’ll just have to wait until enough time passes for them to become less important (though a tax lien MUST be paid off).
In the meantime, it’s important to make any and all payments on time. That includes rent, utilities, phone and cable services, and medical bills. Unfortunately, none of those vendors will report your good payment history, but any of them will report a past due balance or a broken lease or contract.
If you have a long history of late payments it may be an indication you don’t fully understand the importance of making payments on time.
Lenders will consider these factors in a low credit score. But each will present unique challenges in improving your score. Generally speaking, a score that low won’t have an immediate fix. And that’s why you may need to borrow before you have a chance to make improvements.
With that in mind, let’s look at borrowing when you have bad credit for credit cards, auto loans and mortgages.
Common document requirements for a loan application when you have bad credit
When you apply for a loan there are certain documents you’ll be required to furnish, though those can vary from lender to lender, and from one loan type to another. Here are the documents typically required when you apply for most loans:
- Your most recent pay stub and W-2(s) to document your income.
- Evidence of Social Security or pension income (award letter or 1099).
- Contact information for your employer (the lender will verify your employment directly).
- Copies of completed income tax returns for the past two years, if you’re self-employed or work on commission.
- Make, model and value of your car; VIN number if you’re applying for an auto loan.
- If you’re paying or receiving child support or alimony, list the amount you’re paying or receiving.
- Bank or brokerage statements, or even retirement account statements.
- Written explanations for credit problems, including documentation of extenuating circumstances (job loss, medical events, divorce, etc.).
If you’re applying for a loan with poor credit, especially with a bank or credit union, you should be fully prepared to go big on the last item above.
The idea is to show that your credit problems originate from an extenuating circumstance. That can be a job loss, medical events or divorce. You’ll need to provide both documentation of the events, and a well-worded explanation of what happened, and why it won’t continue in the future. In some loan situations, the additional credit documentation can turn a decline into an approval.
How to improve your credit
Simply put, bad credit locks you out of mainstream lending sources, forces you to find loans in unlikely places, and leaves you paying high interest rates under very strict terms.
That’s a situation you need to get out of – as soon as possible. In fact, the best borrowing strategy of all if you have bad credit is to improve your credit before applying for the next loan.
There’s no magic way to improve your credit. It will take months, even years, depending on the causes of your rating. You should also avoid shortcuts, like turning to credit repair services. They’ll charge you a bunch of fees, and they may or may not significantly improve your credit.
Throwing out some options:
- One option is to try Experian Boost – it’s free and an alternative to credit repair services which can be costly, fraudulent or possibly ineffective. Experian Boost can be ideal for a lot of people who need to increase their credit score, but just don’t have the time or money for other solutions.
- Start by getting a copy of your credit report, and paying close attention to any derogatory information it provides. If you see any information that’s reported in error, you’ll need to contact the creditor and get resolved. You’ll probably need to provide documentation proving your point. And if the entry is resolved in your favor, make sure the creditor reports the correct information to all three credit bureaus.
- If there are any past due balances, pay them off promptly. For larger balances, see if the creditor will accept a smaller amount in full payment of the balance due. Always get written confirmation of the settlement from the lender!
- If you have high credit card balances, gradually pay them down. High credit card usage, also known as a high credit utilization ratio is almost as bad as having late payments.
- Finally, avoid applying for new loans until you substantially improve your credit. Too many credit inquiries can also hurt your credit score.