If you happen to have bad credit, you're not alone. It does make it challenging to get a good car loan. However, challenging doesn't mean impossible. Despite your past financial mistakes or misfortunes, taking the proper steps to prepare for your car purchase can set you up for a better financial future. On the other hand, rushing into a car purchase without a plan can send you spiraling into a debt cycle that's difficult to stop. Although it may seem like no one is willing to help, there are many resources out there for shoppers with compromised credit. Before heading to the dealership, take these 5 steps to get on the right track. 

1. Plan for the 20-Percent Down Payment

save up for a down payment

Buying a car without a down payment is possible for some, but for car shoppers with bad credit, a down payment is oftentimes the difference between an approved and a rejected car loan application. Before heading to the dealership for a test drive, make sure you've saved up some cash to put down for the vehicle. A car down payment shows lenders that you have the financial stability to handle your monthly car payments. It can also reduce the interest rates you're offered. 

The average recommended down payment for a new car is 20% of the purchase price and the recommended down payment for a used vehicle is at least 10%. Even if you can't come up with the full down payment, some money down is better than nothing. If your car purchase isn't an emergency, start putting away money every month for the down payment and when you have enough saved up to cover the vehicle you want, you can move forward. 

2. Check Your Credit Report and Correct Errors

checking bad credit report

Many car shoppers with compromised credit believe their credit history is worse than it really is. Falling into this group isn't just bad for your self-confidence, it can cause you to get taken advantage of. Car shoppers who believe they have a lower credit score than they do are more likely to accept an unfairly high-interest rate and to go with the first loan offer they receive without shopping around. 

You're eligible to receive a free credit report every 12 months from all three credit bureaus including Equifax, Experian, and TransUnion. Request a copy from each bureau and look over your credit report to determine which credit category you fall into, then check for any errors. Some of the most common errors include late or missed payments that were actually paid on time and actions that happened a long ago and should have been removed from your report. If you find any mistakes, appeal them to boost your score. When you're ready to apply for auto financing, make sure you're offered an interest rate that's fair for your credit category. 

3. Get Pre-Approved For a Car Loan

car loan preapproval

Car shoppers with good credit can usually just walk into a dealership and get a good car loan offer from the F&I office, but those with compromised credit don't have that luxury. Without getting pre-approved for a car loan, car shoppers with bad credit will run into one of two scenarios: either their car loan application will be rejected or they'll get an offer with an interest rate so high that it puts a significant strain on their finances. The good news is there is a third option that offers a better chance of getting approved for an auto loan and mitigates the interest rate hikes. This option is car loan pre-approval.

The process of getting pre-approved for a car loan is different than a traditional car loan application because it opens up your options to multiple loan offers. Instead of applying for financing at the dealership right before you purchase your car, plan ahead and apply for pre-approval through a bank, credit union, or online lending company (we'll cover each option in the next step). Once you're pre-approved, you'll receive a loan amount, interest rate and loan terms which you can compare to find the financing that will save you the most money over the terms of the loan.

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4. Consider Alternative Lenders 

banks vs. credit unions

If you've applied for auto financing through a bank and weren't approved you're not alone. Car shoppers with compromised credit frequently run into this roadblock because banks evaluate the risk of a potential borrower and make their decision largely based on the borrower's financial history. Alternative lender options available to shoppers with compromised credit include credit unions, Buy-Here-Pay-Here dealerships, and online lenders that specialize in bad credit auto financing. 

While banks are for-profit entities, credit unions offer a better chance at approval because they are non-profit, account holder-owned institutions. As a result, they are usually more flexible with the criteria for accepting car loan applicants. Membership is required to open an account with a credit union and the options include local, federal, military, and employer-based credit unions. Do a search for options near you to find a credit union you're eligible to join. 

buy here pay here dealership
A Buy-Here-Pay-Here dealership will both sell you a car and finance it.

Buy-Here-Pay-Here (BHPH) dealerships may be able to get you into a car, but it doesn't come without a price. Unlike traditional lenders who scrutinize your credit history and find the risk is too high to approve your loan, BHPH dealerships only look for a steady income. BHPH dealers will handle the financing first which determines how much they will lend and then offer a specific selection of vehicles that are available for this amount. Most BHPH dealers will also require in-person payment which means the borrower has to come into the dealership at least once or twice per month.

Online lending companies who specialize in subprime auto financing can offer a solution if you've had trouble getting approved through traditional lending institutions. Although your low credit score will likely raise the interest rates available to you, comparing multiple offers will allow you to find the lowest rate. Get pre-approved by a handful of lenders (without even leaving your house) and choose the best car loan interest rate and terms to move forward with.

5. Research Affordable Used Cars

looking at used cars online

Going to the dealership "just to window shop" or "just to test drive" can be a dangerous move. The temptation of seeing that shiny new car can cause you to bite off more than you can chew. Choosing an affordable used car and shopping around for the best price before you set foot in the dealership will set you up for success. The less your car costs, the smaller your monthly payment will be and the more likely you'll get approved for a car loan. 

First, determine a realistic budget for your vehicle and start your car search online to compare the available inventory. With new car prices hovering around $36,000, going with a used car ($20,000 average) will be a smart choice, especially since you'll be bypassing the high depreciation rates of new cars. When you drive a new car off the lot, it depreciates by as much as 20%. The depreciation of new cars puts you at a higher risk of being upside down on your car loan which means you'll owe more on the vehicle than it's worth. Find an affordable used car, have a down payment ready, get pre-approved for a loan, and choose the best interest rate. You'll not only get the car you need, but you'll also start improving your credit by paying it off every month. 

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