Last updated Dec. 29, 2017.
It’s tough to get by without a car in California. You probably live too far away from work or school to walk, and maybe even too far to bike. You could take the bus, but then you’re at the mercy of the bus’s schedule. With a car, you have the freedom to go where you want, when you want. But cars are expensive, and most people can’t afford to just buy one in cash. That’s where the car financing industry comes in —you can take out an auto loan and pay off your car over time.
An auto loan, like any other kind of loan, comes with an application process. You’ll have to fill in your financial information and the auto lender will run a credit check. If your credit is high enough and your income is stable enough, you’ll get the loan. If you have no credit or low credit, however, you may have a much harder time getting approved.
In recent years, auto lenders have been stepping in to fill that gap — subprime auto loans are now at near-crisis levels. More than $1.2 trillion in auto loans are outstanding debts in the U.S., with 20% of new car loan originations for borrowers with credit scores below 620. These bad credit car financing companies will provide car loans to people with low credit or no credit. On the one hand, that’s a good thing — people who wouldn’t otherwise have access to loans now have the ability to purchase a car. On the other hand, it’s a dangerous thing. These subprime auto loans tend to have high interest rates and other qualities that make them dangerous for borrowers.
How does bad credit car financing work?
Your credit score represents the risk that you’ll default. The lower your score, the higher the risk that you won’t be able to pay off your bills. That’s why lenders check it — they want to know whether you’re likely to pay them back. So why are some lenders providing bad credit car financing if the borrowers are more likely to default?
They’re not doing it out of the goodness of their hearts. They make up for the riskiness of the loans by charging higher interest rates. In other words, the loans are much more expensive than traditional car loans from banks and credit unions. For example, a loan on a new car worth $20,000 in California made to a borrower with a “poor” credit score between 600 and 649 could come with an interest rate of over 8.75%; that same loan made to a borrower with a credit score below 599 could result in interest of more than 11.5%.
In contrast, average car loan rates for prime borrowers are well under 5%.
Bad Credit Car Loan Rates
As mentioned above, these loans can help people with bad credit get cars that they otherwise couldn’t. The problems arise with the terms of the loans.
First, these loans are expensive. If you take out a $5,000 auto loan at an interest rate of 4.5%, you’ll pay almost $600 in interest over the life of the loan and your monthly payments will be just over $90. If your interest rate is 13%, you’ll pay more than $1,800 over the course of the loan and your monthly payments will be more than $110.
Second, the majority of bad credit car financing goes toward used cars and the average loan has a 6-year maturity. Cars depreciate quickly, and this setup puts borrowers at a high risk of owing more than their cars are worth if they try to sell them down the road. In addition, if you default and your car is repossessed, you may face a collection lawsuit and wage garnishment for any deficiency (the difference between what your car sells for and what you owe).
Finally, the lenders don’t necessarily care if you’re actually capable of repaying the loans. For a traditional loan, your lender will look at your income and expenses and lend only as much as you can reasonably pay back. Subprime lenders, however, aren’t as strict about their underwriting standards and may be giving out larger loans than borrowers can handle. The lenders package the loans up, convert them to securities, and sell them to investment companies. They no longer own the loans, so it doesn’t cost them anything if you don’t pay them back. That means they’re inclined to give out loans no matter what. In November 2015, for example, Skopos Auto Receivables Trust sold a portfolio of bonds built from subprime auto loans. By February 2016, 2.6% of the cars had been repossessed or their owners had filed a bankruptcy and 12% were more than 30 days past due — meaning the owners had made no more than a single payment.
This is the bottom line: bad credit car financing can leave borrowers with larger debts, without checking if they’ll be able to repay them, and with a high chance of owing more than their cars are worth.
I’m Struggling to Get Financed for a Car or Make Payments. What can I do?
You’re not alone. There are billions of dollars worth of subprime auto loans out there and the default rate is over 12%. In fact, subprime loans make up about 1/5 of the total auto loans in the U.S. If you’re struggling to make your loan payments, there are a couple of things you can do:
- If your credit score has improved since you took out the loan, you may be able to refinance and get a lower interest rate. You’ll need a score in the 700-range to get better rates.
- If you’re dealing with temporary financial trouble, you can work with your lender. Let them know what’s going on, how you’re planning to remedy the situation, and how long you expect it to take. They make the most money when you keep paying, so they’re frequently willing to work with you to help you get through a rough patch. They may delay your payments for a couple of months or lower your interest rate, for example.
If you can’t refinance and you don’t expect your financial situation to change anytime soon, it may be time to consider getting out of the loan. You can voluntarily surrender your car, but remember that it’s treated the same way as a repossession on your credit report. You may also consider filing a bankruptcy. It won’t wipe out your car debt, but it will wipe out credit card, medical, and other unsecured debts to free up some cash. It will also wipe out your personal liability for the car, so you won’t be on the hook if it gets repossessed and sells for less than you owe.
The Bottom Line
Subprime lending was at the root of the housing crisis in 2008 and some experts are concerned that the subprime auto loan market will be the next to fail. If you’re struggling with bad credit car financing, we may be able to help. Contact our experienced Los Angeles bankruptcy attorneys today for a free debt evaluation.