A bad credit score usually raises a red flag for financial institutions and could lead to a loan rejection. However, there are other ways to secure a vehicle loan even with a bad credit score.

What is a credit score and how does it affect loan applications?

Credit scores reflect a person’s creditworthiness by assessing their credit history. This is based on past credit spendings, how well they manage debts payments, and how high the chances are for the institution to get the borrowed money back.

The rule of thumb is that a high credit score may mean that the individual has better control over their credit and has a higher chance of paying back their debt. This, in turn, means less risk for lenders.

Having a bad credit score or an uncomfortable amount of debt is considered highly risky for lenders. For lenders to approve an application despite a bad credit rating, they usually decrease the borrowed amount/capital and/or increase the interest rate. This means a higher out of pocket cost for the purchaser.

Alternatives to getting a car loan

Getting rejected for a vehicle loan isn’t the end because some lenders give people with bad credit scores a chance to secure a loan.

Related-party loans
A loan applicant could consider asking their parents, relatives, or friends if they could consider arranging a loan.

In some cases, related parties and friends could offer loans with friendlier terms and a lower interest rate compared to than what credit institutions offer. However, it is advisable to transact at an arm’s length basis to avoid relationship strains that may arise.

Another related party alternative is to consider asking someone with a good credit score to co-sign or guarantee the loan application.

The applicant will still be the debtor with a bad credit rating, but if financial institutions see that the debt is guaranteed by someone with good credit rating, there is a higher chance of getting the loan approved.

If approved, remember that any late or missed payments also pull down the guarantor’s credit score.

Credit unions
Try applying from a credit union instead of a big bank or the dealership. Credit unions are not-for-profit organisations that consider individual circumstances, especially with its members.

Peer to peer lending
A peer to peer lending scheme could provide the necessary capital because it operates with a more relaxed criteria for lending.

Credit score still matters to the lenders because individual lenders still need to be protected, but instead of dealing with structured lending institutions, applicants deal with strangers who can understand their circumstances.

Car lease
Another option is to get a car lease instead of purchasing one.

Leasees get to drive the car they want, but only under specific terms and conditions. They also need to return the vehicle when the term ends unless a provision states that they can purchase it off the leaser.

A business owner can also apply for lease if the vehicle will be used for business. However, this means forfeiting some rights under credit laws.

They could also consider taking over the lease of a current leasee who can no longer continue with their agreed term.

Window shop for loans

Exert the necessary effort to look for various options and offers in applying for car loans. Lenders and dealerships can offer different terms, conditions and payment schemes. Be aware of extra features in the loan offers because some can potentially further aggravate an already bad credit score.

Secure a copy of your credit report and bring it when you shop around for cars. Credit reports may give different values of the credit score depending on which agency issues them. Just remember that credit checks can further lower the credit score if done frequently.

The Australian Securities and Exchange Commission’s (ASIC) has a free mobile application called “MoneySmart Cars” that helps loan applicants see the upfront and ongoing costs of loan offers. This can reveal how good a loan offer is and can help save money in the long run.

Best advice

Instead of buying or leasing a car, individuals with bad credit rating are advised to work on repairing their credit score.

Clearing debts and clarifying mistakes in their credit report can raise the score and increase the possibility of loan approval.

This information has been sourced from ASIC and DMV.org.