How to Get the Best Car-Loan Rate Despite a Low Credit Score
The best rates go to those with good credit, but there are still ways to save money if your credit has room for improvement
By Benjamin Preston
If you’ve ever financed the purchase of anything—whether it was a car or a refrigerator—you know your credit score is key to getting a favorable interest rate. The best deals are reserved for those with the best credit, but that doesn’t mean you have to accept the worst terms if your credit isn’t so good.
A good credit score usually means you can get a lower interest rate, while a poor credit score—or having no credit because you’ve never financed anything—can push you into the subprime category. To the lender, a low credit score means you’re a higher risk—or, according to their statistical calculations, less likely to pay back the loan. So you end up having to pay a higher interest rate, which adds significant finance costs on top of the purchase price of the car (or anything else) you’re buying.
Anywhere from a fifth to a quarter of all car loans fall in the subprime category, according to analysts at TrueCar, a major online automotive marketplace that is partnered with Consumer Reports. That’s more than 5 million car loans per year.
But your credit rating may not be the only factor driving up the rate on your car loan. If you finance through the car dealer, using a lending option that they broker rather than a bank or credit union, the rate is often higher because the dealership takes a cut for acting as the middleman.
Further, a recent study shows that car-loan rates for Black or Hispanic consumers can be higher because of bias and weak government oversight.
“Sadly, there remains discrimination in both the granting of credit and rates some consumers pay for their loans, but knowing as much as you can as soon as you can really helps,” says Alain Nana-Sinkam, vice president of strategic initiatives at TrueCar. “Having a better idea of what sort of rates you might qualify for will help you identify if you are not getting the terms you should.”
Even so, experts say there are ways to keep the rate on your car loan as low as possible. Although Consumer Reports and other auto-loan experts recommend improving your credit rating before applying for a loan, real-life circumstances don’t always allow enough time to do that.
Perhaps the best way to get a lower rate is to see what your bank or credit union is offering instead of the car dealer.
“Before you go to the dealership, shop around and compare interest rates for yourself, so you know what’s available based on your credit and income,” says Chuck Bell, programs director for CR’s advocacy division.
“Many lenders will give you a direct loan, so you don’t have to work through the dealership to get their often higher-priced financing," Bell says. "You can apply for loans to banks or credit unions, and some lenders will prequalify you for the amount you are seeking with a soft credit check, which won’t hurt your credit score.”
In general, those with excellent credit will get the best rates. People with poor credit ratings or no credit—those who haven’t had to make payments on credit cards and other monthly bills lately—will pay the highest rates. Rates are marked up on subprime loans because the borrower is more likely to default on the loan.
“Your score is designed to be a predictor of your risk of paying back what you borrow,” says Nana-Sinkam. “It looks at your history of paying bills, credit cards, auto, home, and personal loans on time, and uses that information to predict your future behavior and therefore your risk.”
A low credit score means you typically won’t qualify for the catchy zero percent offers highlighted in ads for new cars, and it means that you could pay hundreds or even thousands of dollars more in interest over the life of the loan.
According to Experian, one of the major credit reporting agencies, credit scores are broken down as follows:
Excellent, 800-850: This category includes 21 percent of borrowers and gets the best rates.
Very Good, 740-799: A quarter of borrowers fall into this category, which promises better-than-average interest rates from lenders.
Good, 670-739: This segment covers 21 percent of borrowers, and Experian says only 8 percent of the group is likely to become seriously delinquent on payments.
Fair, 580-669: This category is considered subprime and comprises 17 percent of borrowers.
Poor, 300-579: Only 16 percent of borrowers are in the deep subprime category, which carries the likelihood of extra fees, deposits, or loan application rejections.
“The sad reality is that if you’re a subprime buyer, you’re going to pay more interest than someone with a good credit score,” says Matt DeLorenzo, managing editor at Kelley Blue Book.
How to Save Money
In conversations with lending-industry experts, CR found that there are a number of ways to save money, even if you have a suboptimal credit score.
Know your credit score. Experian recommends checking your credit score at least once per year as a matter of course. That way, you’ll know where you stand so that you can manage expectations regarding loan eligibility, and be aware of what you have to do to bring up your score. You should also look for errors in your credit report, which can affect your score, Bell says.
“Luckily there is no shortage of sites you can visit online to get a free credit score," says Nana-Sinkam. “All the major credit bureaus offer one free credit report annually.”
If there’s time, improve your score. A credit score can be improved in a number of ways, mostly by paying bills on time. Always pay credit card and other bills when they’re due, even if it’s only the minimum payment. This is good advice for any loan—the more you pay up front, the less you’ll pay in the long run.
Bring a bigger down payment. “Having a bigger down payment reduces the amount of loan you need, and a smaller loan means less interest,” says Amy Wang, associate director of Credit Karma Auto. “A down payment can be in the form of cash, a trade-in vehicle, or a combination of the two.”
Get prequalified. Much like knowing your credit score, getting prequalified for a loan from your bank helps manage expectations about what’s possible.
Talk to your financial institution and see what’s available. Nana-Sinkam says that before you get prequalified, it’s a good idea to review your credit report to see whether there are any disputable items. Every little bit helps, and just a few corrections can get you a better rate. Getting approved for a loan before you go to buy a car gives you yet another bargaining chip.
“Have a rate you can take to the dealer to see if they can beat it,” says DeLorenzo. “The dealers may have access to programs that can get subprime borrowers a better rate.”
See what the dealer’s manufacturer is offering. If you’re in the market for a new vehicle, manufacturers such as Chrysler, Hyundai, and Kia often have programs for subprime borrowers, says DeLorenzo. You have to dig around on their websites to see what’s out there, and keep in mind that this type of deal is going to be found on less-expensive cars.
“Most of the subprime lending you’ll see is on entry-level and economy cars—the bottom end of the product lineup,” he says. “I don’t think any manufacturer wants to leverage a subprime buyer into a high-margin vehicle like a luxury car or a pickup truck.”
Consider buying a used vehicle. In general, used cars cost less money, and the value of a used car is more likely to stay stable for longer than a new car, which will depreciate rapidly. That means used-car transactions pose less risk for the lender, and there is a higher likelihood that a subprime borrower will be approved for a loan.
“In our experience, most subprime buyers shop the used-car market because they’re looking for vehicles at a lower price point,” says Wang.
Report suspected discrimination. Racial discrimination in auto lending is nothing new. Ally Financial, which services loans for several automakers, settled a discrimination lawsuit for $80 million only a few years ago.
An academic report published in December 2019 found that Black and Hispanic borrowers were 1.5 percent less likely to be approved for a loan and that they pay 0.7 percent higher interest rates, regardless of their credit. The study found that although bank loans—which are federally regulated—were much less likely to be discriminatory, more than 80,000 Black and Hispanic borrowers were denied loans they would have been approved for had they been white.
Loans offered by dealers are known as indirect loans, because the dealer arranges financing through a third-party company. But the dealer doesn’t have to share loan offers that come back from the lender with the borrower. This is how they mark up loans for profit, and as outlined in last year’s study, how dealers were able to charge minority borrowers more. A federal rule enacted in 2013 placed auto lending under the guidance of the Consumer Financial Protection Bureau (CFPB), and reduced discriminatory auto lending by 60 percent. But the rule was overturned by Congress several months before the 2018 midterm election.
“Unlike mortgage lenders, who report each application through the Home Mortgage Disclosure Act, auto lenders do not systematically report application or loan level data, making it difficult for regulators to monitor lenders for discriminatory practices,” says Erik Mayer, one of the authors of the study. “We find the strongest evidence of discrimination in the Deep South, the Ohio River Valley, and parts of the Southwest. Our estimates of discrimination in auto lending correlate strongly with state-level measures of the prevalence of racial biases.”
If you suspect discriminatory lending, Mayer suggests filing a complaint with the CFPB or the Federal Trade Commission.
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