No one wants to be in a position to apply for bad credit financing when they need a reliable vehicle, but it’s often the only opportunity available for someone with a low credit score. The cycle of bad credit is exhausting and often seems endless because many lenders aren’t willing to assume the risk and approve a loan for someone with a low score. Without the loan, you can’t afford a vehicle; without a vehicle, you can’t get to work to earn the paycheck you need to pay your bills on time. The cycle is brutal, and it’s one that many Americans face each day.
There are hundreds of articles about how to get a subprime or second-chance car loan, commonly known as “bad credit financing.” But there’s something integral missing in many of these guides because they fail to outline how you can actively work to rebuild your credit after you qualify for the loan. Having bad credit isn’t the end of the world and there are ways to improve things. What do I mean?
Get to Know the Lender
In many cases, by the time you finally get approved for a subprime car loan, you’re so excited that you’ve finally cracked the code and found someone willing to take a chance on you that you’re quick to accept and sign on the dotted line. However, while the approval is exciting, don’t let it stop you from doing your homework. You need to get to know the lender and learn how the car loan will work to your benefit.
One of the first questions you should ask is if the lender reports your payments to the major credit bureaus. While this seems like a given for any lender, it’s important to clarify. Sometimes, lenders that offer deep subprime loans or buy-here-pay-here dealerships don’t report your payments, meaning the loan will not actively help rebuild your credit. Instead, you’re making monthly payments without moving the dial on your credit score. For those interested in rebuilding, these types of loans are less appealing and mean the search for a subprime auto loan isn’t over.
You Bought a Car, Now What?
Once you find a reputable lender that approves the loan and reports your payment activity to the credit bureaus, finalizing the sale is simple. However, it’s also when the real work of rebuilding your credit begins. By now, you know your credit score, but there still might be some questions about how an auto loan can impact that pesky three-digit number that will follow you around your entire adult life. Moreover, securing the loan was stressful enough that the idea of exploring additional ways to boost your credit might seem like a punishment. Fortunately, it doesn’t have to feel this way.
First, Demystify Your Credit Score
Your automotive loan, whether prime or subprime, can play a significant role in your credit score. However, recognizing that impact means taking a deep dive into what comprises your credit score. For example, the three major credit bureaus–Equifax, TransUnion, and Experian–use five factors to determine your creditworthiness. Those factors are payment history, total debt, length of credit history, types of credit, and new lines of credit.
These categories are straightforward, with your payment history making up 35% of your score. So, if your financial past is littered with late payments and past-due balances, you can see how those occurrences have negatively impacted your score. It also explains how your automotive loan can help you turn the tide, but only when you make your monthly payments on time.
The credit bureaus also look at the total amount of debt you have, the types of credit, and new lines of credit. For example, if you’ve applied for five credit cards within a short period, it’s a red flag for lenders because it looks like you need money fast. The same is true if you consistently max out your credit card, skyrocketing your total debt and creating an imbalance between your income and what you owe.
Second, Discover Practical Ways to Diversify
As a young professional just setting out on my own, I followed the advice of a popular financial expert that encouraged a cash-based system that led me to cancel my credit cards. While it seemed like a great idea, I didn’t consider what it would do to my credit since I essentially wiped the slate clean. As a result, my score dropped because there was nothing to demonstrate my creditworthiness. Not only that, but it reduced my overall available credit, which also negatively affected my score.
When I finally purchased a home and a car, my score consistently increased until life events (marriage and kids) led me to sell my house and trade my car for a family-friendly alternative. My husband co-signed the auto loan, leaving me only one line of credit. My credit score remained stagnant for months until I paid off my vehicle and saw my score plummet. Alternatively, my husband’s score increased because his credit is diversified with a mortgage, auto loan, and credit card.
The valuable lesson here is to diversify your credit as soon as possible and not rely solely on one factor–an auto loan–to help you rebuild. While a cash-based system is excellent, a credit card is still necessary to build your credit history and establish your creditworthiness. There are many practical ways to diversify your credit, like getting a credit card or a secured personal loan at your local bank. A credit card fulfills the need for revolving credit, while an auto or secured personal loan fulfills the need for installment credit.
Third, Know How to Monitor Your Score
Another essential tool in rebuilding your credit is recognizing that knowledge is power. It’s important to know your credit score and monitor changes. At the same time, you need to do this without negatively impacting your score. For example, the credit bureaus consider “hard inquiries” negatively, dinging your score every time someone runs your credit to qualify you for a loan or line of credit. These inquiries need to be rare because, as mentioned, numerous hard inquiries signify financial trouble. There’s typically an exception for numerous inquiries in a short period, so applying for numerous car loans at the same time shouldn’t hurt your score too much.
Fortunately, you can monitor your score from the convenience of your smartphone and without the negative impact of a hard inquiry. Credit Karma and Experian are excellent tools that give you insights into your score and the factors that affect it. Some credit cards also include credit score tracking and information as part of having your card. These services can send you alerts about changes to your score, updates to your account, tips on improving your score, and other recommendations.
Remember, Slow and Steady Wins the Race
One of the most challenging aspects of rebuilding your score is realizing it won’t happen overnight. While it seems like the credit bureaus are quick to react when you make a late payment or close a line of credit, it feels like they respond at sloth-like speed when you’re doing everything right. That’s when you have to trust the process, dig in, and keep making steps in the right direction.
As someone who has spent a lot of time worrying over that three-digit number and its impact, I can attest that rebuilding is possible for everyone, whatever your score. All it takes is determination and a willingness to take some time and explore your options, even beyond finding a second-chance auto loan. With baby steps and a willingness to commit to making your payments on time and finding practical ways to diversify your credit, you can slowly push the needle on your credit score from poor or fair to good, very good, and excellent. It can be difficult to have patience with these kinds of things, but the results and benefits (like how much easier it will be to buy a car next time) are well worth it.