9 August 2023 Concept Car
Ultimately, car finance always comes down to interest rates. You can haggle for a better purchase price, try to get the best conditions, and spend days working out the best model for you.
But interest rates ultimately determine the cost of a loan. They reflect the risk you pose to the lender. They make the difference between a good and a bad deal.
And yet, even experts routinely overvalue the importance of interest rates.
That may seem like a contradiction. But it will all make sense, we promise. Want to save money and get the best out of your next car purchase? Then follow us through this guide.
Securing a car loan with poor credit isn’t easy. But it certainly isn’t impossible. At Concept Car Credit, we help thousands of bad credit drivers get behind the wheel again each year. And there’s no mystery behind that at all.
What it does require is a solid understanding of the various factors that contribute to credit risk.
Lenders take into account several aspects when assessing the level of risk associated with lending to individuals with poor credit. By familiarising yourself with these credit risk factors, you can gain insights into how lenders evaluate your creditworthiness and make informed decisions to improve your chances of obtaining favourable interest rates for your car loan.
Four risk factors stick out in particular. Each of these has the potential to significantly increase your interest rate.
One of the primary credit risk factors is your credit history.
What is the difference between the “credit history” and “credit score”? Simply put, the former is a detailed overview of your selected transactions over the last years. It includes late payments, missed payments and defaults. The score then calculates a single number which reflects the relation between good and bad payment behaviour.
This matters because lenders review your past borrowing and repayment behaviour to evaluate your reliability in meeting financial obligations.
A positive credit history, characterised by timely payments, responsible credit utilisation, and a minimal number of delinquencies or defaults, can enhance your creditworthiness and potentially lead to better interest rates.
Instances of late payments or delinquencies can significantly impact your credit risk.
Lenders view late payments as indicators of financial instability and may associate higher risks with borrowers who have a history of delinquencies.
Minimising payment delinquencies is essential to demonstrate your commitment to honouring financial obligations and increase your chances of obtaining more favourable interest rates.
The amount of outstanding debt you carry is an important credit risk factor.
Lenders consider your debt load and assess your ability to manage additional financial obligations. High levels of existing debts may raise concerns about your capacity to handle additional loan payments, potentially resulting in higher interest rates.
Obviously, debt matters more if you also have a low income. Vice versa, it may matter very little if you earn a great wage. This is why lenders tend not to look at the absolute debt but rather, the ratio between income to risk.
Either way, paying down existing debts can reduce your credit risk and improve your chances of securing better interest rates. Start by consolidating debt to one account and/or credit card and then working your way down to zero.
Bankruptcies and other negative indicators, such as tax liens or collection accounts, can significantly impact your credit risk.
These events suggest financial challenges and may lead lenders to perceive a higher risk in lending to you. As a consequence, they will increase interest rates for a loan. A bankruptcy in your credit report may in actual fact make it very hard to get credit at all.
While recovering from such situations takes time, demonstrating responsible financial behaviour post-bankruptcy can gradually rebuild your creditworthiness and increase your chances of obtaining more favourable interest rates.
Depending on your credit risk factor, the interest you’ll have to pay on any given loan may be agreeably low or sky high. The big question for those with bad credit is therefore very simple:
Will you be able to afford a car loan?
Analysing your loan affordability is a crucial step when seeking a car loan with poor credit. It involves carefully assessing your financial situation to determine the loan amount you can comfortably afford.
An analysis does not sound like fun. But it will help you determine a realistic budget for loan repayment and make informed decisions to secure a car loan that aligns with your financial capabilities.
And, as you’ll find out, there are a few simple steps you can take which will greatly help you in your quest to get the best interest rate for your car finance plan.
Evaluating your income is the obvious first step to start your loan application process.
Lenders naturally consider your income as an indicator of your financial capacity to handle loan payments. The higher your income, the more likely you are to qualify for attractive interest rates. Assessing your income allows you to gauge the loan amount that suits your financial situation and increases your chances of obtaining better interest rates.
It is also very important to consider financial obligations, such as rent or mortgage payments, utilities, insurance, and living expenses. Evaluating these obligations allows you to determine how much income is available for loan repayments and ensure that you can comfortably manage the additional financial responsibility.
Low incomes are usually associated with high interest rates. You can, however, compensate for a low income by either reducing your spendings or high savings. A joint applicant can also improve your chances of a reasonable deal.
Most buyers look at absolute numbers. Lenders, on the other hand, love to look at ratios. Here’s why: Ratios reveal a lot by comparing two related numbers to each other. And that’s not a bad thing at all. In fact, ratios, as a decision making tool, are far more fair.
Probably the most important of these ratios is the Debt-to-Income ratio (DTI). Lenders calculate your DTI by comparing your monthly debt payments to your monthly income. A lower DTI ratio indicates a healthier financial situation and suggests that you have more income available to cover loan payments.
Let’s emphasise that last point once more: The better your DTI, the lower your interest rates will most likely be. By evaluating and managing your DTI, you can demonstrate financial stability and potentially get better interest rates.
Assessing your income and your spendings and calculating your DTI are useful. But they are still not the same as budgeting for your next car.
This is because you really want to define exactly how much you can and want to pay towards interest each month. Especially the “want” part of that is vital. Even if you can afford to pay another £50 for your car loan, you need to be sure you can deal with the loss of financial freedom this entails – this is money you can no longer spend on going out, nice clothes, or other essentials.
Creating a budget specifically tailored to loan repayments is therefore essential for loan affordability analysis. It involves evaluating your monthly expenses and identifying areas where you can make adjustments to accommodate the additional loan payment. But it also means realising what you do not want to cut down on.
By budgeting effectively, you can determine the loan amount that fits within your financial framework and enhances your chances of obtaining better interest rates.
There is a direct relationship between the amount of money you want to borrow and the interest rate you have to pay.
By understanding this relationship between the loan amount and interest rates, you can make informed decisions about the loan size and potentially secure more favourable rates.
Lenders assess the risk associated with lending a specific loan amount to borrowers with poor credit. Higher loan amounts generally carry higher risks, as they require larger monthly payments and may strain borrowers’ financial capacities.
These larger loans will also take longer to pay off. And the further off in the future the final payment is, the less certain both you and the dealer can be that you’ll still be in a stable financial situation at that moment.
Lenders may mitigate this risk by charging higher interest rates for larger loan amounts. By being mindful of the loan amount, borrowers can evaluate the impact on their monthly budget and consider options to reduce the loan size if necessary.
The loan-to-value ratio (LTV) is closely related to the absolute loan amount. You won’t hear it mentioned often when it comes to getting a good interest rate for your loan. But it is, in fact, a key piece of the puzzle.
The LTV is the ratio of the loan amount to the appraised value of the vehicle. A lower LTV indicates a smaller loan amount relative to the value of the car.
Here’s why this is relevant: Lenders often consider the LTV when determining interest rates for poor credit car loans. A lower LTV may result in more favourable rates, as it reduces the lender’s exposure to potential losses.
How to achieve this? Simple: You can either reduce the LTV by
a) picking a less sought-after model
b) picking an older model generation or a lower graded car
c) making a down payment (more on that in a second)
Finding the right balance between the loan amount and interest rates is crucial for borrowers with poor credit. By striking the right balance, you can choose a loan amount that aligns with their financial capabilities and potentially secure more favourable interest rates.
Down payment considerations play a significant role in securing a car loan with poor credit. Making a substantial down payment can positively influence the terms and conditions of your loan, including interest rates. On the other hand, any money paid in advance reduces your financial freedom and reduces your ability to effectively cope with unexpected challenges.
By understanding the importance of down payments and the factors to consider, you can increase your chances of obtaining more favourable interest rates for your car loan.
Down payments have never been popular. Of course they haven’t. After all, you’re taking out a loan precisely because you don’t have a lot of readily available cash.
By asking for a down payment, dealers seem to ignore this simple fact. Now, you’re burdened not just with monthly loan repayments. You also have less of a safety cushion to protect you.
Then again, a down payment does actually save you money. The more you pay upfront, the less you’ll have to pay over the course of the term. Or, to put it differently: Down payments are a great tool to bring down the interest rate.
By reducing the principal balance, you may have the opportunity to secure better interest rates, as the lender’s risk is mitigated by the lower loan amount.
Lenders love even a small down payment. But it can also have a positive effect on your own financial psychology.
Making a down payment demonstrates your commitment to the loan it underlines that you are willing to invest your own funds in the purchase and have a vested interest in the success of the loan. It’s like a tangible starting point.
And for the lender, of course, this commitment can lead to increased confidence and potentially result in more favourable interest rates.
A down payment reflects financial stability and responsibility. Lenders view borrowers who can make significant down payments as less likely to default on their loan obligations. This perception of stability can translate into more favourable interest rates, as it reduces the lender’s risk associated with lending to individuals with poor credit.
Making a sizable down payment also establishes an equity position in the vehicle. Equity represents the value of the car that you own outright, as opposed to the amount financed. Having equity in the vehicle provides a level of security to the lender and may result in better interest rates for the loan.
At CCC, we decide on a down payment together with you, based on your financial situation. We do encourage down payments but understand this may be a high commitment for you. Ultimately, you need to feel comfortable with your payments if we want the loan to succeed.
Are zero down payment auto loans a terrible idea?
This is an often-overlooked aspect of the car buying process. And yet, it seems so obvious: Car finance is not an island. It is embedded into the economy at large. So clearly, if we’re in a boom phase, loans will be easier to get by compared to a recession.
Understanding the impact of these factors is crucial for borrowers seeking car loans with less-than-perfect credit. By exploring the relationship between economic conditions, the lending climate, and interest rates, you can gain insights into the broader market dynamics that affect their loan terms.
Let’s take a look at them in turn.
Economic conditions encompass factors such as inflation, unemployment rates, GDP growth, and overall market stability. These may appear to be unrelated to car finance. And yet, even if the influence is subtle it will undeniably manifest itself in some form.
During periods of economic strength and stability, lenders may be more willing to extend credit and offer more favourable interest rates to borrowers with poor credit. Conversely, during economic downturns or periods of uncertainty, lenders may tighten their lending criteria and offer less favourable rates.
Does this mean that you should spend hours reading financial news and taking up an economic course? Hardly. But being at least aware of the prevailing economic conditions can help you anticipate the lending environment and respond accordingly – for example, by holding off on buying a car for a little longer.
The lending climate refers to the conditions and trends within the lending industry. You may well be aware that there are times where it is generally easier to access a loan. And then there are periods where it seems almost impossible even for those with a decent credit score.
The lending climate sounds like a vague term. But you can easily make it more concrete by looking at factors such as interest rate fluctuations, lending policies, and competition among lenders. Market interest rates directly influence the interest rates offered by lenders for car loans. These rates are determined by various economic factors and serve as a benchmark for lenders when setting their rates.
The more favourable the conditions under which dealers and banks can themselves borrow money, the more favourable the conditions will be at which you can borrow money from them.
Again, knowing about the current lending climate can be useful if you are able to postpone your purchase – or act quickly, if the climate is favourable. Timing can play a crucial role in securing better interest rates for poor credit car loans.
Post-loan assistance programs offer valuable resources and support to borrowers after obtaining a car loan. These programs provide guidance on budgeting, credit management, and financial planning, empowering borrowers to maintain a healthy financial trajectory.
Participating in post-loan assistance programs can equip you with the knowledge and tools necessary to improve your financial situation. By taking advantage of these programs, you can potentially improve your creditworthiness and increase your chances of obtaining better interest rates in the future.
If you have access to one of these, they are definitely worth considering. They won’t however, reduce the interest rate for your loan.
If interest rates on your loan are very high, some dealers will advise you to take up loan insurance.
Loan insurance options offer added protection to borrowers and lenders in case of unforeseen events that may affect loan repayment. These options can include insurance coverage for disability, unemployment, or extended warranties.
By opting for loan insurance, borrowers can have peace of mind knowing that they have financial protection in challenging circumstances. This additional security can also potentially lead to better interest rates, as it reduces the lender’s risk.
The thing is that car loan insurance presents a financial challenge in its own right. It’s expensive and adds another financial burden to the equation when really you should be removing financial obstacles.
9 August 2023 Concept Car