According to the most recent data, 27% of all car loans made in the U.S. last year went to subprime borrowers, or those buyers with FICO credit scores below 620. While this can be a good thing if the loans are done right (substantial down payment and a fair price), as it gives more people access to reliable transportation, many times car dealers prey on customers with subpar credit, knowing they may have limited options for financing.
Here are three ways to prevent yourself from becoming a victim.
Do your research first
If you know your credit is less than ideal, there are three pieces of information you need to know before you start negotiating on a car: your credit score, the interest rate people with your score are getting, and the value of the car. Let's take these one at a time.
Your credit score is important to know because it tells you where you stand. And, not all subprime borrowers are in similar situations. For example, a score of 600 could mean you missed a few credit card payments a few years ago. A 500 could mean you filed bankruptcy, had a house foreclosed, and have several collection accounts. Even relatively small differences in your credit score can make a big difference.
And, make sure that the credit score you are looking at is the same thing your lender is going to see. The FICO score is used in the vast majority of lending decisions, and the only place you can buy your own FICO score from all three credit bureaus is at myFICO.com. Don't fall for those "free credit score" sites.
Different credit scores mean different interest rates. The myFICO website also maintains a "loan savings calculator" that is updated very frequently with the interest rates you should expect to pay based on your score. For example, a borrower with a 620 FICO score can expect to pay about 10.5% on a 48-month new car loan. A borrower with a 550 can expect to pay 17%.
This knowledge lets you walk into a dealership knowing what you should pay. And dealers make money on financing. It's not uncommon for a bank to approve a customer at 5% interest and the "finance guy" tells them a 6% rate is the best he can do. The dealership simply pockets that 1% "spread."
And finally, you should know what the car is worth. The good news is that in this age of smartphones in every pocket, this should be easy. A couple of numbers entered into kbb.com and you'll know the fair retail price of the car.
Knowing these three pieces of information will make you a much more informed customer, and you'll be less likely to get ripped off.
Know what not to say to the dealer
There are three different financial issues to worry about when buying a car: the price of the car itself, the interest rate you get, and the amount the dealership will give you for your trade-in. Notice that the monthly payment amount isn't one of them – rather, if you get these three things right, the payment will take care of itself.
Still, many dealers insist on asking this question to every single buyer that comes through their doors: "how much can you afford to pay per month?" Under no circumstances should you give any numerical answer to this question. Doing so is giving the dealer permission to rip you off by charging whatever price and interest rate they feel like, as long as it stays under your limit.
And, the three issues I mentioned above should be three separate transactions. Negotiate the best price (not the best monthly payment) on the car, then negotiate how much you'll get for your trade-in, and only then should financing even be discussed.
People say this all the time, but are rarely willing to actually do it. If you feel for any reason that you aren't getting a good deal, walk away. Thank the salesperson for their time and head for the exits. This can be stressful, especially if you really want the car, but it's not worth getting ripped off over.
And make sure you check out a few dealerships. Car dealerships are competitive with one another, and there are few more powerful negotiating tools than an offer from another dealership to sell the same car for a certain price.
The bottom line is that you should never go into the process without doing your homework first, especially if you have so-so credit. If you are a well-informed car buyer, it'll be really hard for any dealership to take advantage of you.