What are Second-Chance Car Loans?

These loans can be a great way to buy a car even with lower-than-average credit and start repairing your credit.

Laura Leavitt | 

Aug 10, 2022 | 4 min read

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For a variety of reasons, many people find themselves with credit that is low enough to qualify as "subprime" — what is casually referred to as bad credit. The good news is that lenders recognize that even those with subprime credit need transportation. While these loans could cost more, second-chance auto loans give you the opportunity to get a much-needed vehicle and can be part of rebuilding your credit if you make all your payments consistently.

Understanding Second-Chance Auto Loans

Second-chance car loans are loans made specifically for people with lower credit. Because the loan is secured by the car and comes with higher interest charges, some lenders offer these kinds of loans. However, they are riskier than lending to people with stronger credit and often involve a higher risk of default.

Generally, second-chance car loans are issued to people whose credit falls into either subprime (FICO scores 501 to 600) or deep subprime (FICO scores 300 to 500). These borrowers have typically run into issues with debt or making payments in the past, but they haven't had enough time yet for their credit to improve to above 600.

Considerations to Keep in Mind

While a variety of banks, credit unions, and dealerships offer second-chance car loans, lenders aren't entirely equal. You'll want to compare multiple potential options that you qualify for to ensure you're getting the best loan.

Precomputed Interest Limits Early Payback

One of the challenges with second-chance car loans is that they sometimes use precomputed interest instead of the simple interest on other auto loans. Precomputed interest requires you to pay all the interest on the loan even if you pay the balance off early. If you think you may be able to pay ahead on the second-chance auto loan, you might want to shop for a lender who will consider using simple interest instead.

Spot Delivery Can Change Loan Terms

While most lenders and dealerships will explain their financing well, there's a strategy for getting cars sold that could result in a loan with surprising terms. Occasionally, salespeople will allow you to take the car home while they find a lender. This is called spot delivery. The salesperson may then call and say that no lender was willing to finance the loan at anticipated terms. That leaves you in a difficult situation that forces you to either choose a different loan with less favorable terms or bring the car back. Keep an eye out for this practice by asking if your loan is fully approved or pending approval, and not taking possession of the car until it's fully approved.

3 Options Before Choosing a Second-Chance Car Loan

In many cases, a second-chance car loan may be exactly what you need to keep your family moving, get yourself to work, and boost your credit. However, before signing one, take steps to get a better deal on your car loan and feel confident in your choice:

1. Review Your Credit Report and Dispute Incorrect Information

You can request a free credit report every year. Doing so allows you to look at the reasons why your credit is currently low. Some items on your credit report will be legitimate, but if any credit hit is due to a reporting error, you can follow the process to dispute that information. As a result of a successfully disputed transaction, your credit may go up over time.

2. Use Alternative Transportation While Saving and Raising Credit

If you have access to a bus, borrowed car, or carpool, these options may save you money for your down payment, while you are waiting for your credit score to rise. While it can be tough to find alternative transportation, if available to you, it can help you qualify for a loan with better terms in six months or a year.

3. Consider a Credit Union Pre-Approval

It can be difficult to tell if your dealer is offering a good interest rate or not if you haven't shopped around first. For this reason, seek a pre-approval at a bank or credit union first, potentially getting good terms on your loan. Some dealerships could still have the best deal with their financing, but getting pre-approved at one or more banks or credit unions can give you information to compare when you visit the dealership.

Choosing Wisely When Seeking a Loan With Bad Credit

While you may pay a bit more for credit when seeking a second-chance car loan, this secured form of lending is often still available to you if you look around and start working on your credit immediately. Paying down this higher-interest-rate loan can be the first step to raising your credit score and finding a better future lending interest rate.

Laura Leavitt

I love a good spreadsheet and will happily calculate compound interest all day, but my biggest focus is helping people achieve their financial goals. That could be saving up for a dream car or calculating the right car payment for your budget so you can get a reliable daily driver. I research and write about personal finance so that making great financial choices becomes easier for us all.