What Is a Second Chance Car Loan?
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Summary:
Second-chance car loans are loans available to individuals who have poor credit and may not be able to get a traditional auto loan. Sometimes known as “subprime” car loans, these loans typically have much higher interest rates and less favorable terms than traditional car loans. If you are considering a second-chance auto loan, make sure you can afford the loan and that you understand the length, the interest, and any other loan terms.
Second chances are some of the most valuable gifts in the human experience. If you failed a test, you might get a second chance to retake it. If you threw a dinner party and the food turned out ghastly, then you might also get a second chance to throw a dinner party. In the world of credit and auto loans, there are options for second chances as well. If you are looking to purchase a vehicle and your credit score is shaky because of previous mistakes, a second-chance auto loan might be an option for you.
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What exactly are second-chance auto loans?
Second-chance auto loans are bad credit auto loans reserved for people with poor credit and, in some cases, no credit at all. Typically, the loans are offered by subprime lenders or by dealerships with in-house financing. However, some traditional financial institutions such as banks or credit unions will offer them as well. Second-chance auto loans will most likely come with a higher APR than a traditional loan, and the payment terms might also differ substantially.
In many cases, taking out a second-chance auto loan can help people mend their bad or poor credit, as long as the on-time payments are reported to the relevant credit bureaus. However, second-chance is a blanket term for auto loans, and thus the loan terms can differ significantly depending on the lender and their desired loan structure.
Subprime auto loans
Second-chance auto loans are often referred to as “subprime” auto loans. For those with painful scars from the subprime mortgage crisis in 2008, the term might be familiar. However, subprime merely refers to loans for people with credit scores that are considered lower than the standard. To understand what constitutes poor credit, you can refer to the table below from the Consumer Financial Protection Bureau.
| Credit scores | Range |
|---|---|
| Deep subprime | <580 |
| Subprime | 580-619 |
| Near-prime | 620-659 |
| Prime | 660-719 |
| Super prime | 720+ |
Second-chance auto loans will have substantially higher interest rates for those that have poor credit based on where they are on the credit scale. People with super-prime or prime credit scores will most likely be able to obtain an auto loan via the traditional lending routes. However, those with subprime or near-prime credit scores (580-659) might only have the option of a second-chance auto loan when looking for car financing options.
Second-chance auto loans have some fundamental features in their loan structure that differentiate them from traditional auto loans. These are:
Higher interest rate
Interest rates can differ substantially on second-chance car loans. This is because, in the case of loans given to individuals with poor credit, the lender is taking on more risk that the loan won’t be paid back. Expect to pay 5%, 10%, or even 15%+ more in interest than you would on a traditional car loan.
Larger down payment
With traditional auto loans, all sorts of lenders offer a “no-money-down” option. With this type of loan, you can take the car off the lot and start driving it right away, with just your agreement to make the monthly payments. A second-chance auto loan often requires that you pay a significant down payment. In some cases, this can be as high as 10% of the value of the vehicle.
Loan terms and timeline
The average length of a car loan in the United States is around 70 months. Some second-chance auto loans will require that you sign up for a longer-term loan in the region of 72-84 months. This longer loan term typically results in the buyer paying extra interest on the loan that they otherwise wouldn’t have in a more traditional time frame. It can also lead to the concept of being “upside-down” on the car, in which the loan amount is more than the car is worth.
Extra fees
Like many below-prime loans, extra fees are common in second-chance car loans. Many states will have caps on interest rates in auto loans. For the lender to work around this, they will incorporate extra document processing fees and sometimes hide the fees in the price of the car.
Dubious lending practices
Lenders in the subprime or below-prime business will offer loans to individuals who have a high probability of defaulting on the loan. In fact, in many places, this is deemed a deceptive business practice and is illegal. For example, Credit Acceptance Corp., one of the largest second-chance auto loan providers, recently settled a case in Massachusetts for $27.2 million. A court deemed that they purposely marketed high-interest loans to borrowers who they knew had no ability to repay them.
Where to get a second-chance auto loan
As second-chance auto loans are considered a riskier form of lending, not everyone offers them. Here are some places where you might be able to find a second-chance auto loan.
Subprime auto lenders
Some subprime auto lenders will allow you to pre-qualify directly online for second-chance car loans or a bad credit auto loan. Carvana auto loan is an example of an online lender that will pre-qualify you before you purchase a car.
Before accepting a loan offer, make sure you are getting a good deal by comparing the rates and terms of multiple lenders. SuperMoney’s auto loan offer engine allows you to get rates from leading auto lenders without hurting your credit score.
Car dealerships with subprime lenders
Subprime lenders are typically indirect lenders, meaning they work via auto dealerships rather than having borrowers approach them directly. When a dealer advertises rates for a second-chance or subprime auto loan, they are typically advertising the terms of their lending partner.
In-house dealership financing
Some auto dealers are able to offer in-house financing. This means that rather than outsource the loan from a third-party lender, they are able to use their own capital to finance the loans. In some cases, these dealers won’t actually go over your credit with a fine-toothed comb. They will merely make sure that you reside somewhere and have a provable income. However, with some exceptions, in-house dealership financing loan terms do not differ substantially from third-party lenders that work with auto dealers. Expect to pay similarly high interest rates and in some cases, have a longer loan term as well.
Traditional financial institutions
Some traditional banks, credit unions, and financial institutions will offer second-chance auto loans, but it’s rare. Capital One, for example, works with consumers that have credit scores as low as 500. However, it’s crucial to comprehend that these loan terms will be similar to what you would receive from a third-party subprime/second-chance lender. Just because a name brand issues the loan doesn’t necessarily mean that you are getting better terms than you would from an unfamiliar lender.
What to look for in a second-chance auto loan
Perhaps you had a problem in the past that has haunted you like a ghost in the form of bad credit. If you really need a vehicle, yet your credit report stipulates that you should go the second-chance route, here is what to look for.
Will the loan improve my credit rating?
If you are going to take out a second-chance loan, you also want to give your credit score a second chance. Your credit score deserves it! However, in order to improve the score, you need to make sure your auto loans are reported to the three major credit bureaus. Make sure you monitor your credit, and if it fails to improve, then speak to your lender to make sure they report your timely payments.
Is it affordable?
If you are looking for a second-chance auto loan, you probably want to avoid having to look for a third- or fourth-chance auto loan in the future. In this case, affordability is crucial. If you can’t afford the payments, you will default on the loan, thus relegating you to the deepest version of deep subprime. Make sure you model your costs out to avoid defaulting on the loan.
Do I understand the interest calculation?
Read all of the fine print and avoid dubious practices by shady auto dealers. How is the interest calculated? Is it a loan that offers payment terms with simple interest or pre-computed interest?
With pre-computed interest, you pay all of the interest on the full term of the loan. If you pay it off early, you are still on the hook for the interest. Suppose it’s a five-year loan with five years of interest; that five years will be paid regardless under the pre-computed loan structure. With simple interest, you can reduce your interest amount payments by paying your loan off early.
Do I understand all the terms?
Do you understand all of the small print that might affect the length and terms of the loan? Make sure that all small print is clear, and do what you can to avoid shady dealers using yo-yo financing. Yo-yo financing occurs when you agree with dealer terms for loan financing and drive the car off the lot. When you arrive home, the dealer says your financing has been rejected, but he has a “new program” for you, typically with worse terms.
Do I really need a car right now?
Honestly, the best course of action is to delay the car purchase until you have mended your credit score. Then you will be able to get a more traditional auto loan. It might sound difficult, particularly if you live in the United States, where the majority of urban development has been geared towards cars. However, light rail improvements and bus routes are constantly progressing, and public transportation might be an option to consider.
FAQ
What is second-chance credit?
Second-chance credit is credit available to people who have poor credit scores. It’s a second chance to get a loan and hopefully improve your credit in the process.
Can you get a car loan with an under 500 credit score?
Yes, some lenders will offer loans to car buyers with a credit score under 500. However, just like most bad credit car loans, the terms will probably not be favorable.
What is the lowest credit score for a car loan?
There is no set lowest credit score needed to obtain a car loan. If your score is below 580, though, it could be difficult to obtain a loan.
How do you get a car loan after being denied?
You can try to get a car loan from another lender. If you have been denied by a bank or credit union, for example, you can look at second-chance car loans or dealership financing.
How can I get approved for a second-chance car loan?
You can quickly do a preapproval through an online lender. You will need to submit your income, credit history, and relevant identification documents.
How easy is it to get a second-chance car loan?
As long as you cross all the Ts and dot all the Is correctly, it’s relatively straightforward. Be sure to read the fine print, though, to make sure you will be able to pay back the loan.
Key takeaways
- Second-chance car loans are loans designed for people with poor credit scores who can’t get traditional auto loans.
- Second-chance car loans are typically offered by specialty lenders or dealerships, although they are also available through a few banks and credit unions.
- Higher interest rates, longer loan terms, and different loan structures are common in second-chance car loans versus traditional auto loans.
- It’s crucial to make sure that a second-chance car loan is right for you. Make sure it improves your credit score and that you understand all of the terms.
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