What is a second-chance auto loan?

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In a Nutshell

Second-chance auto loans can seem like a gift for car buyers with rocky credit. But these loans — which are simply auto loans marketed to people with rough credit histories — typically have high interest rates and fees. And not every lender offers them. If you’re considering a second-chance auto loan, make sure to shop around for the best rates and check your loan terms to make sure you can repay your debt.
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Second-chance auto loans, sometimes called subprime car loans, are exactly what they sound like: auto loans for car buyers with rough credit histories.

Maybe it’s a past bankruptcy or loan default that’s hurting your credit profile. Whatever the case, if you’re in the market for a car and searching for a second-chance auto loan, you’ll want to keep a few things in mind.

Second-chance loans often come with higher interest rates than auto loans for people with stronger credit. Some lenders offering second-chance loans might also require having auto-tracking software or a mechanism to disable the starter in the car you buy, just in case you fail to make payments.

Read on to learn if a second-chance auto loan is right for you.

Can I get an auto loan with ‘bad’ credit?

What would your credit look like to land you in the second-chance or subprime category? It can be subjective. What one lender or dealer sees as “bad” credit might qualify as the lower end of “average” credit for another.

That’s one reason shopping for auto financing and comparing options from a few different lenders is a smart move.

“There are different definitions of subprime,” says John Van Alst, staff attorney for the National Consumer Law Center. “It depends on who the lender is.”

The Consumer Financial Protection Bureau provides five levels of credit scoring.

  • Deep subprime (below 580)
  • Subprime (580 to 619)
  • Near-prime (620 to 659)
  • Prime (660 to 719)
  • Super-prime (720 or higher)

Another good thing to know: If you get financing through a dealer, the interest rate may be higher to include the dealer’s fee for handling the financing, Van Alst says. Remember, the higher your interest rate, the more money the lender stands to make on the loan. You might feel like you can’t be picky because of your credit situation — but that’s actually even more reason to look at a number of options to see if one might give you better terms than another.

You’ll also want to ask if your loan has precomputed interest or simple interest. With precomputed interest, you’ll be charged interest on the original length of the loan, no matter how quickly you pay it off. For example, a seven-year loan comes with seven years of interest, even if you pay it off in five years. With simple interest, you can save on interest if you make extra payments toward your principal or pay the loan off early — assuming your loan has no prepayment penalty.

How can I get a second-chance auto loan?

The borrowing process for an auto loan is generally the same, whether you have great credit or not, says Rebecca Borné, senior policy counsel for the Center for Responsible Lending.

Before you visit a dealer, see if you can get car financing through a bank or credit union.

You can start with the financial institution you already bank with and branch out from there. Comparing options from several lenders — you can even try to get prequalified — can give you a better idea of the loan terms available to you. Prequalifying doesn’t guarantee loan approval, but it can tell you how much you might be able to borrow, and what your interest rate and payments might be.

If your bank or credit union doesn’t preapprove you for a loan, it may be able to recommend steps for credit repair to help you get a loan in the near future.

Just like a car buyer with good credit, once you’ve compared loan offerings from banks and credit unions, it’s also a good idea to see what kind of terms a dealer may offer.

Cons of a second-chance auto loan

Second-chance auto loans often come at a cost. Here are a few things to look out for.

  • Higher interest rates: Your second-chance loan will likely come with a higher interest rate than an auto loan for someone with stronger credit. Along with some other factors, credit scores help lenders measure the likelihood you’ll repay your loan. For riskier borrowers, lenders often charge higher interest.
  • Down payments: Since lower credit scores can be a factor marking you as a riskier borrower, the lender might want a larger down payment.
  • Extra fees: Car dealerships may add fees or increase the price of the car if your credit is shaky, Van Alst warns. “Many states have caps on interest rates. Because dealers are selling you financing and selling you the car, sometimes what they’ll do is just mark up the price of the car.” One way to get ahead of this: Research car values so you’ll have a handle on what the vehicle is really worth and what others are charging.

Watch out for ‘yo-yo financing’

Another thing to look out for when the car and loan come from the same place is “yo-yo financing.”

How it works: You sign a contract with the dealer and drive home in the car. A few days later, you get a call: The dealer couldn’t get the loan at the negotiated terms. You may have to pay a higher interest rate, make a bigger down payment or both — and if you can’t, you’ll have to return the car.

Your best bet is to leave the car on the lot until your financing is finalized and all of the terms are in writing. “Read through the contracts,” Van Alst says, and be wary of clauses with phrases like “financing subject to approval.”

Consumers with good credit can encounter dealer loan snags, too, Borné says.

“But the stakes can be higher for subprime borrowers,” who can end up being more vulnerable, she adds.

Fast Facts

Are there any programs available to make cars more affordable for lower-income individuals and families?

The National Consumer Law Center is spearheading Working Cars for Working Families, a loose national coalition of local programs aimed at making cars affordable for lower-income individuals and families. Depending on the program and a person’s need, cars can be sold on a sliding cost scale or given away for free, says Van Alst, who’s also the project director. “It’s a real challenge, but people are trying different things in different places.”

Should I get a second chance auto loan?

Even if you can qualify for a second-chance auto loan, should you apply for one?

Here are a few things to ask yourself to help you with your decision.

  • Is the loan affordable? Given your present income and obligations, can you make the monthly payments easily?
  • Does the loan length fit the expected lifespan of the car? A seven-year loan on a five-year-old car that doesn’t normally last 12 years could spell trouble, Borné says.
  • Does the deal seem fair? Never assume this is the only lender who’ll work with you or the only loan you’ll ever get, Borné advises.
  • Can you do without buying for a little longer? In some cases, waiting to build or rebuild your credit can be an option — as long as you can get by using other transportation without endangering your job or safety, or creating some other emergency situation.

Bottom line

A second-chance auto loan can be a lifesaver — but it can also be a financial burden in the long run. Doing some research on loan options and car values, taking a clear-eyed view of your current finances and comparing your options will help you make a better choice for you and your wallet.

About the author: Dana Dratch is a personal finance writer (and coffee fanatic). She covers credit, money and lifestyle issues. Read more.