Finding a Second-Chance Auto Loan

Borrowers with bad credit may turn to second-chance auto loans to buy a car and possibly restore their credit.

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Ads for "second-chance auto loans" may catch your attention if you need to buy a vehicle and have bad credit, past bankruptcy or a previous car repossession.

That's especially true if your goal is to mend your credit. The term "second-chance" implies that making on-time loan payments could offer a fresh start.

But you should be aware that a second-chance auto loan banner hanging from a car dealership can mean something different from a second-chance loan at a credit union or bank.

All second-chance car loans aren't the same

A second-chance auto loan typically refers to a loan with less stringent requirements to help borrowers with bad credit qualify.

But Ryan Kelly, auto finance program manager with the Consumer Financial Protection Bureau, explains that “second-chance auto loan” is not a standardized term and often refers to different types of financing.

"We've seen buy here, pay here car dealers use it to refer to a loan where you don't need a credit score, or a high credit score, to get a loan," says Kelly. "We've also seen credit unions use it to refer to their credit rebuilder products."

According to Kelly, a key difference is that credit unions and banks usually report on-time loan payments to consumer credit reporting agencies, which can help your credit score. Buy here, pay here dealers often do not.

What to look for in a second-chance auto loan

If you apply for a car loan advertised as a second-chance loan, hoping it will help you finance a car and mend your credit, you should pay close attention to your loan paperwork. Know what you are precisely agreeing to before signing anything.

Here are some things to look for and questions to ask:

Does the lender or dealer report on-time loan payments?

If you're determined to make payments on time, make sure those payments are reported to at least one of the three major credit bureaus. You don't want to pay for a year and find your credit score remains unchanged, because payments haven't been reported.

Are late loan payments reported to the credit bureaus?

Some BHPH dealers report late payments but not on-time payments. If you're applying with a BHPH dealer, you will want to know upfront what is reported to credit reporting agencies and what isn't.

If you think there's a possibility you won't make payments on time, you may actually be better off going with a BHPH dealer that doesn't report them. But you're going to pay more for the loan and will have no opportunity to help your credit if you do make payments on time.

What's the loan term?

Often, car dealers will focus only on the monthly payment you can afford. So, for example, if you say you can't pay more than $500 a month, they may extend the loan term to hit your desired payment amount.

But a longer-term loan, such as a 72- or 84-month loan, can cost you more in interest over the life of the loan. It can also lead to being upside-down on a car, meaning you owe more on the loan than the car is worth, which isn't good if you're trying to improve your financial situation.

What's the annual percentage rate?

Make sure to look at the loan's APR and not just the interest rate. The APR is the amount you will pay each year to borrow money (expressed as a percentage), and it includes any lender fees, which may be substantial for bad-credit borrowers. Lender fees vary, so the APR is the most accurate way to compare loans. You can use NerdWallet's auto loan calculator to input the APR, loan amount and term to see your total cost for financing a car.

Does this loan have features to help me restore my credit?

If your goal is to help your credit recover, look for a lender with a credit-builder program — often referred to with names like "second chance" or "fresh start." According to the National Credit Union Association's December 2021 profile report, about 13% of credit unions say they offer a credit builder program, although the report doesn't define if all include auto loans.

Auto loans through credit-building programs typically have specific requirements, such as requiring you to use direct deposit into a checking account with an automatic transfer of your car loan payment. This is a way to help you build a history of on-time payments.

In addition, some second-chance auto loan programs will lower the borrower's rate after making a certain number of on-time car payments. Others offer an option or requirement of no-cost credit counseling.

Should you shop rates for a second-chance auto loan?

Kelly says that people with subprime or deep subprime credit often don't shop around for auto loans, but it can be "particularly important for those consumers to shop around." He notes that there are "significant differences in median interest rate by lender type in subprime auto lending."

The FICO credit scoring model defines a subprime borrower as someone with a credit score of 619 or less.

A September 2021 CFPB Data Point report states that in a sample of subprime auto loans, the average interest rate at banks was approximately 10%, compared to 15% to 20% at buy here, pay here dealerships.

Kelly suggests borrowers first try to get an auto loan preapproval from a credit union or bank to find the best rate instead of relying solely on dealer financing. By doing this, car buyers will have a baseline rate for negotiating at the dealership. He also stresses the importance of asking if your on-time loan payments will be reported to credit bureaus.

Chris Kukla, a CFPB senior markets and policy fellow with a primary focus on auto lending, adds that it's a good idea to take auto loan paperwork home to review before signing. He suggests this course of action regardless of where you apply for your loan. Even if you're told otherwise, you have the right to receive a copy of the filled-out Truth in Lending Act disclosures to take with you. That way, you can closely review the loan terms and possibly compare loans without feeling pressure to sign quickly.

Finding the right second-chance auto loan

Wherever you get a second-chance auto loan, find a program that supports your goal if you intend to restore your credit. Loans with features that encourage on-time payments, and lenders that report those payments to the credit bureaus, provide a better opportunity to get the car you need and begin mending your credit.

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