America is a car society, and unless you live in a place like New York City with its excellent mass transit systems, you need a car to get around. However, if you have bad credit, you could be in for some frustrating times when you go to lease or buy a car. Most people know if they have bad credit and may have already had sticker shock experiences when quoted interest rates or down payment requirements during their car search. Another option for getting a car is a lease and you may wonder which way is the best for you: lease or buy?
Leasing a car is basically paying rent on a car instead of buying. You never actually own the car but make monthly payments on the depreciation of the vehicle over the life of the lease. When the lease is up, you own nothing. However, leasing gets you more car for the money. If you lease a $20,000 car for 3 years and at the end of the three years the car is worth $12,000, you’ve only made payments on the $8000 depreciation. If you purchased the car, you would be making payments on the whole $20,000.
In addition, you don’t need to put money down (or you need to put very little) on a lease, whereas if you are buying a car, it pays to put down 10 to 20 percent.
For those people who always want a new car, a lease is a way to go. Most leases last 2 to 3 years, and when the lease is over, it’s time to get a new vehicle.
Since you are really just doing a long-term rental on the car, you aren’t building up any equity in it. While buying a car is always a losing proposition (depreciation really eats up the value of a vehicle over time), at least when you finish making payments you have something worth some money.
Another problem with leasing is that there are mileage restrictions. The average driver puts 12,000 miles a year on a vehicle, and leases come with the restriction of 10,000 to 12,000 miles annually. If you can’t keep it under that, you’ll be paying more for your lease or paying a penalty at the end of the lease.
Lastly, you must take really good care of your car. Dealers expect that you will return the car in a “like new” condition. If your car shows extra wear and tear, you will be paying additional fees to bring the car back to mint condition.
In order to qualify for a lease, you need to have good to excellent credit: a FICO® Score of 700 or more (the top FICO Score is 850). You’re considered subprime on scores of 699 to 599; below this, you are considered “super subprime.” You can still qualify for a lease with subprime credit, but you will be required to put more money down and make higher payments than someone with good credit.
If you have bad credit, you could possibly take over someone else’s lease, called a lease assumption or lease transfer. You just take over a car and lease payments from someone who wants out of their lease. You will still have to qualify for the lease, but the credit criteria are less than the criteria for a new lease. One company that does this as its business is Swapalease.com.
Auto loan rates for those people with subprime credit can be outrageously expensive, with interest rates topping out at greater than 20%. However, most subprime loans are 10 to 13% — it pays to shop around.
How do you know you have bad credit? Don’t take anyone’s word that you have bad credit, pull your credit report ahead of time and check your credit score, then do some online comparisons of rates. Don’t go directly to a company that specializes in subprime loans, they will qualify you for one of them, even if your credit is better than most of their customers. Try your hand at a regular lender first to see if you qualify.
Buying a used car always makes the most financial sense, as the highest depreciation occurs within the first two years in the life of the car. However, used car loan rates are often higher than new car rates. When you combine that with a bad credit rating, it may take a little longer to find an interest rate you can live with.
Watch out for add-ons that a dealership or subprime lender makes conditional on the loan like extended warranties, after market services or even insurance. Subprime loan lending contracts are often stuffed with such items.
Your best bet for a low interest rate loan is a bank or a credit union. Credit unions are especially good for those with credit that sits on the edge of a good credit rating, the loan requirements are often less stringent than a bank for a very affordable rate. If you already have a relationship established with a bank, they may be more apt to give you financing if your credit falls just shy of the mark.
Also, make sure that the loan terms are final when you drive away from a dealership if you get financing at the dealer. Some buyers are told days or weeks later that their monthly payment or required down payment has been increased, or the financing is not complete and they must accept a higher interest rate. Victims of this kind of scam pay an average of 5 percentage points higher on their loan rates.
In general, and regardless of credit, leases are not a good idea unless you are the type of person who will always have a car payment (you finance your car purchases) and want a new vehicle every 2-3 years. Leases are often hard to get if you have bad credit, even if you do a lease takeover. Your best financial bet is to buy a car, hang on to it for a number of years and save up money for a newer car after your car is paid off. Financing a car purchase is a profit center for dealerships, and they may not have the best rates. Always shop around so you know if the dealership is competitive. If not, arrange for other financing.