What Is a Second Chance Auto Loan?

Car buyers with poor credit might find it difficult to obtain financing. A second-chance auto loan might be an option if you need to buy a car but are limited in terms of credit. What is a second-chance auto loan? Learn about the requirements for a second-chance auto loan, including how to apply for one and when you should consider this type of loan.

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What Is a Second-Chance Auto Loan?

A second-chance auto loan is a type of financing lenders offer buyers with poor credit. Also known as subprime auto loans, second-chance auto loans are often buyers’ last effort at getting funding for a new car.

Lenders look at more than credit with second-chance auto loans. They might consider things like:

Down payment: The more money you put down on your car loan, the more likely the lender will approve your application. A higher down payment means the lender doesn’t have to lend as much. It also results in lower monthly payments for the borrower, which might be easier for them to make.Income: A high income can sometimes make up for a bad credit score. Having a high income or low debt-to-income ratio proves you can make your car loan payments.Debt: Lenders will also look at your existing debt when determining your eligibility for a second-chance car loan. Having a lot of debt can reduce your chance of approval because it shows you have other obligations. Potential lenders will review the debt listed in your credit report.Payment history: Proving you’re actively improving your credit score might qualify you for a second-chance car loan. Even if you had bad credit previously, avoiding new late payments can help you get a second-chance loan.

Some lenders offer guaranteed loans, which means they promise loan approval. These often come at a rate that’s much higher than the average interest rate.

Who Qualifies for a Second-Chance Auto Loan?

Borrowers usually turn to second-chance auto loans when they have bad credit, or anything lower than a 580 credit score. You might qualify for a second-chance loan if you’re denied a traditional auto loan.

Second-chance auto loans are usually divided into deep subprime or subprime loans. A deep subprime loan covers credit scores between 300 and 500, and a subprime loan covers credit scores between 501 and 600. Car buyers who have previous repossessions or past bankruptcies might benefit from second-chance auto loans.

What to Expect with a Second-Chance Auto Loan

If you’re considering a second-chance car loan, do your research first. Second-chance car loans do come with risks, including:

The Lender Might Require a Higher Down Payment

Many second-chance car lenders require a higher down payment to reduce their risk. The good thing is a higher down payment can reduce your monthly payments and make your loan more affordable. If possible, it might even be a good idea to make a bigger down payment than what the lender requires.

Be sure to factor in precomputed interest, giving you a full monthly payment estimate. You can make the best financial decisions when you have all the information you need.

The Lender Will Likely Charge You a Higher Interest Rate

Most second-chance loans come with higher interest rates. The interest rate is how much the lender charges you to borrow money. Subprime lenders usually charge higher interest rates because they’re entering into a higher-risk agreement. Doing your research and comparing interest rates among lenders is always a good idea. Consider all your loan options to find the best option.

Your Credit History Will Affect Your Rates

Your credit history and score both affect your interest rate. Subprime lenders typically charge rates based on a borrower’s credit. Borrowers with stronger credit might save a little each month with a lower interest rate. Choosing a car within your budget can offer you added financial protection because you know you can afford the monthly payments.

Your Loan Is Secured with Your Car

It’s also important to note that most second-chance auto loans are secured by the car. This means if you stop paying back your loan, the lender might be able to repossess your car. Then, you’re left with a repossession on your credit report and no vehicle to drive. This significantly affects your ability to qualify for additional auto loans in the future.

Your Lender Might Not Report to the Credit Bureau

Traditionally, lenders report on-time payments and paid-off debt to the credit bureaus. This, over time, increases your credit score. Some guaranteed loan approval lenders or second-chance auto lenders don’t report to the credit bureaus. This means you might be stuck paying a higher monthly payment without the ability to improve your credit score.

You Might Have to Pay Extra Fees

Not only do second-chance auto loans come with higher interest rates, but the lender might also charge extra fees. This is why reviewing your loan term before agreeing is important. Compare all your lending options, including the interest rate and the fees. One lender might charge you high origination fees, whereas another might not.

It’s also important to know the details of the loan. For example, some lenders require an automated direct deposit with second-chance loans. This means the money is taken from your account automatically.

You Might Owe Interest in Full Even with Early Repayment

With most traditional loans, you can save on interest by paying your loan back early. Some second-chance auto loans come with prepayment penalties. This means you owe the precomputed interest, regardless of when you pay off the loan. If you plan to pay off your loan early to reduce your interest payments, you might want to search for a simple interest lender instead.

How to Get an Affordable Loan with Bad Credit

If you have a bad credit score, you might have limited options when it comes to financing. If you need a car and can’t wait for your credit to improve, your best bet might be a second-chance car loan. Here are a few things you can do to ensure you still get the best rate, even with less-than-perfect credit:

Know your credit: You want to know not only your credit score but also your credit history. You can expect to pay higher rates if you have a poor credit history. If you have made a lot of on-time loan payments in the last few months, your credit score might increase enough for better loan terms.Improve your credit: If you can wait, an improvement to your credit score can help you save money. Pay off debt before applying for a car loan to qualify for more favorable terms.Buy within your budget: Setting a budget and sticking to it is another great way to keep your monthly payments affordable. Second-chance car loans often come with extra fees, so you’ll want to calculate these into your payment when making your budget. Make sure you can afford the auto loan before agreeing to it.Refinance once your credit improves: Refinancing with a bank, credit union, or traditional lender after your credit score improves can help you save. Evaluate your loan terms and determine when it’s time to reach out to traditional lenders to refinance.Use a cosigner: A cosigner agrees to accept the increased risk of lending to someone with poor credit. If you have someone who’s willing to cosign on your auto loan, you might qualify for better rates.Compare preapprovals: Getting preapprovals ahead of time and comparing them can help you evaluate your lending options. This also helps you compare other factors lenders might consider when making their decisions.

Where to Get a Second-Chance Auto Loan

If you have a low credit score and you need a car, a second-chance car loan might be your best option. Here are a few places where you might be able to get a subprime or deep subprime car loan:

Second-chance dealership: Some car dealerships offer second-chance auto loans. These are often referred to as guaranteed approval lenders.Second-chance financial institution: Some financial institutions also offer bad credit loans.Credit unions: Some credit unions offer guaranteed loan approval options. You might have a better chance with a credit union if you’re already a member of their banking institution.

Always consider all your loan options to find the best deal. Inquire with local and online lenders about their financial products for those with less-than-perfect credit. Some lenders offer different types of loans, and the more information you have, the better financial decisions you can make.

How to Avoid Deceptive Lending Practices

Subprime lenders sometimes take advantage of borrowers with bad credit. While you can expect to pay more for a second-chance auto loan, this doesn’t mean they should take advantage of you.

Spot lending is a common practice. It involves a financial institution allowing you to take the car home until they find a lender that aligns with your buying budget. They then call you and say they can’t find a suitable lender. Instead, they encourage you to sign and agree to their second-chance auto loan, even though it has higher interest rates and fees than you wanted.

A second-chance auto loan might be an option if you need a car right now and have less-than-perfect credit. It’s important to do your research to ensure you know what you’re agreeing to and can make your payments in full and on time.

Finance Editor

Jim Slavik is a financial services expert with 30 years of strategic and operational experience including leading underwriting, loan administration, customer service and collections. He has held C-suite credit operations roles for Fortune 100 and private equity companies for credit cards, personal loans, lease-to-own, auto loans, mortgages, and insurance for prime and sub-prime borrowers. 

Currently Mr. Slavik is an independent financial services consultant for private equity firms and a contributor for expert networks such as GLG, Guidepoint, and Level company amongst others.