Why the Interest Rate on a Bad Credit Auto Loan is High

January 12th, 2016 by

The interest rate on bad credit auto loans are typically much higher than those with good credit. Even though this is an unfortunate fact, there are reasons behind it. These reasons might not be considered “good reasons” in your book if you have or need to get a bad credit car loan, so let’s just call them “justified reasons.” Because while they’re unfortunate, they are still understandable if you step back and look at it from a bigger perspective.

Here are a couple reasons, and a deeper understanding, as to why the interest rates on bad credit auto loans are so high.

Good Credit vs. Bad Credit Interest Rate

In 2015, the bad credit car loan interest rate was on a steady incline, and it’s a costly. Even though you won’t qualify at some places for 0% APR like a consumer with good credit, you still need to keep your head up. Shop around, find the best deal, the interest rate will fluctuate from dealer to dealer, allowing you at least a little bit of wiggle room when it comes to lowering the amount you’ll pay. The interest rate also fluctuates depending on what your credit score is, and you may not actually have bad credit at all. It always pays to figure that out before you go shopping around, that way you know what you qualify for.

Even though it may fluctuate depending on your credit score, the fact of the matter is that if you have bad credit it doesn’t matter what your score is; it’s going to be an expensive interest rate.

A Big Difference

The average interest rate is a big difference depending on your credit score. Obviously, the better credit score you have the better your interest rate is going to be. Typically, credit scores operate in a range from 301-850. A good credit score is considered to be anywhere from 700-749, whereas a bad credit score is anywhere below 600. Your interest rate in 2015 with a credit score below 501 would have been anywhere from 13.16% to 14.51%. Maybe even higher than that, and a little bit less if you are sitting between 501-600.

The average rate is anywhere from 4-6% on a car loan taken out by someone with good credit, which means your interest rate is more than doubled if you have bad credit. But, why is the average rate so high?

Because, You Have Bad Credit

This isn’t me being funny or sarcastic, this is a legitimate reason as to why you have a high interest rate on your bad credit car loan. When subprime lenders like used car dealers or other independent organizations take on consumers with bad credit, it’s a two way street. What I mean is this: on one side of the street you are putting your faith in them to find you a loan for a reliable used car that you can afford. While on the other side of the street, they are taking on a customer with rocky financial history and trusting that you will actually make your monthly payments to the lender. Never thought of it that way, huh?

A Security Measure For Them

If you deal directly with a used car dealership, you will most likely be getting a loan directly through them. In turn, you will be paying them every month directly. They want cash, and generally don’t allow checks or money orders. This way, the only way for you to make your payment for that month is face-to-face at the dealership.

This avoids any “my check is in the mail” or other prolonged excuses along those lines, which could ultimately end up with them losing profit on repossessing your car or another way; neither of which they want to happen.

I know what you are thinking “but I’m not like that!” And I’m not saying you are, but the fact of the matter is, some customers with bad credit have a history of not being financially responsible because they don’t care enough. Therefore, this is the dealers security net for providing you with a loan. But, you can look at it as an incentive to make your payments on time. How is it an incentive? Well, if you make your payments on time and improve your credit, you are able to apply for better financing after that first loan is paid off. Which means the next loan you apply for will have a lower interest rate because of your new and improved credit score. If you miss payments, however, you will dig yourself even deeper into bad credit.

So, look at it in a hopeful light. Even though this high interest rate on your loan is costly now, it won’t be that way forever if you keep up with your payments. Also, now that you understand the dealers are taking a big leap of faith as well, that might make cutting a deal with them easier to swallow. 

It’s the Used Car Dealers Source of Income

Let’s face it, if you have bad credit there is a slim chance of you qualifying for a shiny new car, and no reason for you to. You should look at used car dealerships for something cheap and reliable without the bells and whistles, because all you need is something to get you from point A to point B.

Which brings me to my next point; a more specific reason as to why a used car dealership might have such a high interest rate is because that’s how they make their money on the sale. Typically, the car they get is bought cheap from auction and sold at a lower price, but it’s still reliable and runs fine. It just might be a car that doesn’t sell very well or a minor aesthetic issue. Therefore, it would be hard for them to turn a profit on it under normal circumstances; but these aren’t normal circumstances. They are dealing with consumers who have no where else to go, and they need to keep the business open so they can keep people with bad credit on the road.

Therefore, the only thing left for them to profit off of is the high interest rate. Without that interest rate from their customers, they would not be able to turn a profit and keep their business open for consumers with bad credit who desperately need a car.

In Conclusion…

While going through other lenders is an option, like a bank or credit union, these ones are typically tougher than going to a used car dealer. Most used credit car dealers understand your need for a car, and know how difficult it is when it comes to finding financing for one with bad credit. But, they are still a business.

At the end of the day, they need a way to cover themselves for the cost of a repossession if you stop paying for your loan halfway through the first year. The interest rate can serve as payment for that. On top of that, the car they paid for doesn’t really have a high resale value, and they are dealing with consumers who need a reliable and cheap car to get them down the road. This puts them in an interesting situation: they need to figure out how to sell a cheaper car to a consumer whose only option is a cheap car, while still figuring out how to make a profit. The answer? A high interest rate.

Even though it’s an unfortunate reality, just these two reasons behind why a used car dealer would have a loan with a higher interest rate are should lessen the pain a little bit. You can’t fault them for trying to cover themselves, and they still need to make a profit somehow.