It is a remarkable thing: The UK economy is looking unstable, job prospects for many employees are shaky, the dangers of Brexit are looming on the horizon and private debt is increasing. At the same time, not only are we buying plenty of new cars, but even those with a less than perfect credit score are finding it easier than ever to finance models which long seemed entirely unattainable.
This inevitably raises a question:
How to explain this paradox?
A lot of the seeming contradictions are down to a diversifying market for car finance. Getting a bad credit car loan used to be a highly risky affair, offered by ruthless, shady dealers and featuring brutally exploitative interest rates. Today, some consider the traditional bad credit car loan ‘dead’, replaced by more contemporary and attractive options.
If you’re currently looking for a car loan and worried about your credit score, read on. We have put together the ultimate guide on how to finance your purchase – plus all the details and pitfalls you need to watch out for.
Beware the Snake Oil
Even though bad credit car loans have significantly improved over the past decade, this is not to say that there are no longer any shady deals out there. Especially when it comes to the financing of new cars, recent scandals have highlighted the ruthlessness of some dealers.
Some of these deals involve high-end brands being offered without any need to put down a deposit. In other cases, lenders simply did not perform any financial background checks. As a result, more than half of the recent rise in car sales has been caused by ‘distressed’ households – a deeply worrying development.
As Autoexpress has reported, this could potentially have a detrimental effect on the entire car market. According to Rachel Reeves, the Labour MP for Leeds and former shadow Treasury minister: “In 2008, sub prime mortgages were a big problem – missed by policymakers. Today it’s car loans and other forms of consumer credit that are accelerating. Car companies are vulnerable to bad debt and defaults while buyers are racking up debt that may well turn out to be unaffordable.”
As long as you steer clear of this kind of too-good-to-be-true-deals, however, you should find plenty of decent offers to choose from.
The importance of your Credit Score
Obviously, this doesn’t make things easier if you’re looking for a bad credit car loan. For those with financial difficulties, financing still remains the single most problematic stumbling block when it comes to purchasing a new vehicle. And most of this issue is down to one thing alone: Your credit score.
Essentially, the credit score is a number calculated by lenders to rate your credit worthiness. Each bank, car dealer or financial institution uses their own set of criteria to arrive at this number, so there is no such thing as THE credit score. Whereas one bank may find your rating lacking, another may just find it perfectly adequate.
All lenders will, however, roughly use the same set of data to arrive at their numbers. This data is taken from your credit history, which shows whether you have missed payments in the past and whether there have ever been any payment issues due to overdrawn accounts. Although you can not change the past, these events will eventually be taken off your credit history and you can do quite a lot to re-build your credit score (more on that at the end of this article).
For the moment, it is enough for you to understand that your credit score is an important part in getting any kind of financial deal – from a regular personal loan to a bad credit car loan – and that you should at least know what your credit history looks like to assess your chances of securing financing for your car.
Bad Credit Car Loans: An Overview
Once you’ve established your credit history, you should be able to decide which form of financing is best for you. The following four payment plans are generally considered best for those with a bad credit rating:
- Personal loans: This is the most traditional and well-known form of financing. You borrow a certain amount of money in exchange for interest payments over a fixed amount of time. Personal loans can be arranged with your bank prior to selecting which car you are going to buy or they can be set up with your dealer (which may, interestingly enough, cost you less).
- Hire Purchase: With a Hire Purchase agreement, you’re not buying the car outright. Instead, you’re initially hiring it for a certain amount of time and paying monthly ‘rental fees’. The great thing about a Hire Purchase Contract is that the car belongs to you after you’re payed your final monthly instalment.
- Personal Contract Purchase: On paper, a PCP looks very similar to a Hire Purchase model. Again, you’re hiring the car and paying monthly rates to your lender. The difference between a PCP and an HCP is that with a Personal Contract Purchase, the monthly rates are considerably lower and the time for paying back the loan is longer. However, you don’t automatically own the car at the end of the contract period. Instead, a larger sum of money will still remain, which is referred to as the ‘balloon payment’. Only if you pay this back in full does the vehicle truly belong to you.
- 0% financing: A special deal, which is not always available. With 0% financing, you don’t pay any interest on your loan, which sounds great in principle. However, you will need to make sure to never miss a single payment or else your plan can easily be taken to a higher rate version. Also, these deals tend to require significant deposits of up to 35% of the total value of the car.
Which of these different bad credit car loan alternatives is best for you? Let’s take a closer look at them to find out all about their pros and cons!
Personal Loans: Pros and Cons
A personal loan does not need a lot of explaining. It used to be the standard way of financing any larger investment, and still remains the most familiar financing option for most people. On the car market, however, personal loans are not the most popular or best option available to you.
Why is this?
Mainly, because personal loans have a few important disadvantages, which you should be aware of:
- Personal loans are harder to get than most other bad credit car loans. Credit checks tend to be very strict, conditions severe.
- Although personal loans are usually cheaper than many of the other financing options, they will generally have higher monthly payments.
- Since the car belongs to you straight away, you will need to cover all repair costs.
- You will have to bear the full brunt of depreciation, which can make a serious dent in the resale value of your car.
- With a secured loan, even a single missed payment means you could lose your home.
That said, personal loans allow for a lot of flexibility when it comes to how long you want to take to pay the money back and they also allow you to modify the car in any way you want, since it’s yours outright. And there are alternatives to a secured loan – such as an unsecured guarantor loan – which protect you from drastic measures in case of financial difficulties.
Hire Purchase Contracts: Pros and Cons
Hire Purchase are an extremely popular option for anyone looking to buy a car with a less than perfect credit rating. This is because you do not own the car straight away, which means that it can be used as collateral. On the one hand, this means that if you do not meet your monthly obligations, the car may get repossessed. On the other hand, financial institutions and dealers will be more willing to lend you money even if your financial history has some blemishes.
Some of the other benefits of Hire Purchase include that it is easy to set up and gives you a lot of security, as monthly instalments and interest rates are fixed. Although the term lengths tend to be flexible, you should be aware of the fact that personal loans can be paid back in full quicker. So if you intend to pay off your loan within a short period of time, a Hire Purchase may not be your number one option.
Personal Contract Purchase: Pros and Cons
PCPs are by far the fastest growing version of bad credit car loans. It is not hard to see, why.
With a PCP, you are only paying back a far smaller amount of money compared to a Hire Purchase agreement or a personal loan. Theoretically, you can decide, at the end of the term, to use the resale value of the car to get a new one again based on a PCP scheme. This way, your monthly instalments will remain low even if you’re driving a new, high-end model of an established brand.
There’s a downside to this, however. Just as with a Hire Purchase, missing payments can mean loosing your car again. If you do decide to keep the vehicle at the end of the term and pay back the balloon payment, PCPs can be considerably more expensive than any other financing model. What’s more, these contracts require you to keep the car in perfect condition and you will also be financially punished should you exceed an agreed-upon mileage. If you do return the car in a less than satisfactory state – from the dealer’s point of view – the resale value of the car will be marked down at your expense.
Still, part of these issues can be offset by arranging a ‘Guaranteed Minimum Future Value’ for the vehicle. And if you intend to change cars every so many years, PCPs can actually be a remarkably attractive option, as leading car magazine Auto Express opines.
Rebuilding Your Credit Score
Which of these different options is available to you depends, as we’ve mentioned before, on your credit score. If your rating has been damaged in the past, it is therefore highly beneficial to start improving it before you head out to apply for a loan.
Some of the most useful steps towards rebuilding your credit score are the following:
- Bring back unsettled credit – every little bit helps. Even more importantly, make sure not to miss any payments whatsoever in the future any more.
- Stay with one bank and try to keep the same job for as long as possible – unless you get an offer you can’t say no to. Stability is considered an even higher priority than a few Pounds more or less on your pay check.
- Cancel any credit cards you don’t use. On the other hand, getting a credit card if you don’t have one yet, can ironically be helpful towards improving your rating – at least if you make sure all debt on the card is paid back in time.
- If you have a partner or friend with a good credit rating, you could set up a joint account. This will improve your chances of getting a good deal when applying for a bad credit car loan.
That said, you should be aware of one important thing:
Credit Rating isn’t everything
As Martin Lewis has pointed out, risk is not the only consideration on a lender’s mind. In fact, the most important aspect in a loan is whether it can make the bank money:
“Many money–savers contact me incensed by a rejection: “I’ve a perfect credit score, never missed a repayment, why on earth did they reject me?” This is based on a view that credit scoring is solely about whether people are good or bad risks. In fact it’s about profit. Of course, a bad risk is likely to be seen as unprofitable by many. Yet good risks may still be unprofitable. It could be that you’re applying for a hot credit card cashback deal, but their aim is to build a customer base to cross–sell mortgages to, and you’re not suitable for that.”
This means that there’s always hope when it comes to applying for car finance. As long as you realise this, you may soon find yourself firmly in the driving seat again.