You may think that "no-credit car loans" are the same as "bad-credit car loans," and in some practical ways you would be right. But there are some important differences. Read on to discover those differences – and much, much more.
What is your credit history?
Your credit history is effectively your credit report. That is an electronic file maintained by each credit bureau (Equifax, Experian, and TransUnion are the three biggest) that records who you are (personal identifiers), the credit you've applied for, the accounts you have opened and closed, the payments you have made (and whether they have been on time or late), and your credit limits and balances for any given month. Additionally, credit-related information from public records is kept, including liens, foreclosures, bankruptcies and civil court judgments against you. All that information is usually kept for seven years, after which it is erased, although bankruptcies can hang around for a decade.
Your credit score
Your credit score is something different. It is a three-digit number and is the output of a sophisticated algorithm that electronically crawls over your credit report, assigning a numerical value to each event. The algorithm assigns a greater value to recent events over older ones, meaning black marks on your report lose importance as they age, "like an accident receding in your rearview mirror," as a FICO spokesperson once described it. FICO is the company behind the country's most widely used credit scoring technologies and its website describes the components that make up your FICO credit score:
- Payment history (makes up 35 percent of your score) – Whether you made on-time payments and, if not, how late your payments were. This includes accounts being marked delinquent, in default, and in collection, as well as information from those public records mentioned earlier.
- Amounts owed (30 percent) – This has little to do with the dollar sums you owe and everything to do with the percentage of your available credit you are using. Try to keep your store and credit card balances below 30 percent of your credit limits. That applies both to individual cards and your aggregate balances and limits across all your plastic.
- Length of credit history (15 percent) – The longer you have been borrowing, the easier it is to establish that you are a creditworthy borrower. This includes the average age of all your accounts, so closing one can do short-term harm to your score. FICO says, "... even people who haven't been using credit long may have high FICO Scores, depending on how the rest of the credit report looks."
- Credit mix in use (10 percent) – Your score will benefit if you have a mixture of "revolving credit" (mostly cards) and "non-revolving credit" (fixed-term installment loans, such as mortgages, auto loans, personal loans and so on).
- New credit (10 percent) – Do not apply for multiple loans over a short period. It makes you look desperate and raises red flags. There are exceptions if you are rate shopping for a mortgage or auto loan.
You can check your credit score and then continue to monitor it entirely without charge through the LendingTree Free Credit Score service. You will even get free personalized advice on how best to improve and leverage your score.
No credit vs. bad credit
If you have bad credit, you will have had accounts that were mismanaged. Maybe you made repeated late payments or skipped some altogether. Perhaps you are always maxing out your plastic. It is possible things went so wrong you faced a foreclosure or bankruptcy.
If you have no credit, that is a completely different problem. It means you have borrowed nothing in recent years, or certainly not enough for lenders to get a real feel for whether you are likely to pay back your debts. In the lending industry, this is known as having a "thin file". You may have done nothing wrong but you will be in a similar position to someone who has had serious problems managing their debt – because you will have a low or no credit score.
Probably most people who have thin files are young adults who have yet to get around to borrowing much. But it is easy to imagine others who have no credit: retirees who do not want to be burdened with debt, people who have been working abroad, those who have been in prison ... In 2015, FICO estimated some 53 million Americans do not have credit scores.
It may feel as if you are in a Catch-22 situation: You can't borrow because you can't prove you're creditworthy, but you can't prove you're creditworthy because you can't borrow. Read on to discover some ways around this.
How to get car loans with no credit...is it possible?
No-credit car loans are quite common – at least for now. However, back in May 2017, The Financial Times reported that some U.S. banks are getting jittery about them because they fear "overstretched consumers" might be creating a bubble that echoes the subprime mortgage crisis. In other words, things may be changing and, if you want such a loan, you might want to get your skates on.
No-credit auto loans may be available but they are rarely attractive. They pretty much invariably come with much higher interest rates than those available to borrowers who can prove they are creditworthy.
Unfortunately, paying those high rates is the cost of improving your credit score. Luckily, it need not be one you pay for long. Providing you manage your car loan and other borrowing well, your credit score should rise quickly. So, after maybe a year or so, you should be able to refinance your auto loan to one with a much better interest rate.
8 tips for finding no-credit auto loans
1. Get a co-signer
If you know someone with a good credit score who is prepared to co-sign your loan agreement, you could get a much better deal than if you go it alone. However, you will be asking a great deal of that friend or family member because any failure on your part to keep up with the loan could cause him or her to take a big hit both to that person's bank balance and credit score. Unless you are absolutely sure you will keep on top of the loan, you might decide the relationship you are putting on the line is worth more than any car.
2. Open a bank account
If you do not have one already, opening a checking account with a bank or credit union is a good first step to establishing your credit. Your bank balances do not get onto your credit report (though bounced checks and accounts turned over for collection will) so just having a bank account is unlikely to affect your score. But it is a good foundation to have.
3. Save up a worthwhile down payment
Chances are, you will get a much better interest rate the bigger your down payment. That is because your lender stands to get more of its money back if the loan goes sour.
4. Think "total cost of borrowing"
Car salespeople will try to make you focus on your monthly payment. "If you can afford that much a month, I can get you a much better vehicle than the one you thought you wanted," they will say. But, generally, the only way they can do that is by extending the length of your loan, perhaps to seven years. Ask yourself whether you will still want to own that car in seven years' time. And how expensive that loan will be if you are paying interest over that period. Ask about the total cost of borrowing.
5. Watch out for dealer scams
There are plenty of fine, honest dealers out there. But there are also many scam artists. The Center for Responsible Lending has a list of common cons you should guard against.
6. Be realistic
Your thin file means lenders have no idea how creditworthy you are. And that means, absent a co-signer or chunky down payment, you are going to pay a high interest rate for your borrowing. Insiders suggest you expect anything between 10 percent and 30 percent. However, remember that you may be able to refinance to a better rate in a year or so, providing you manage all your credit accounts well.
7. Beware prepayment penalties
Prepayment penalties are relatively rare but some auto loans come with them. Make sure the one you sign does not include either these penalties or a clause that says it is a "pre-computed" loan. Either of those could make it uneconomic to refinance later.
8. Shop around
This may be the most important of these tips. As with all borrowing, the only way you can be sure you are getting a good deal is to get competitive quotes from multiple lenders. You can do so online, as well as by talking to your bank and credit union. Do all this before you engage with a dealer's salespeople. They are trained to sell finance as much as cars and will likely pressure you to go with their loans. The easiest way to resist is to go armed with other quotes. Of course, if your dealer has the best deal, go with it.
Establishing good credit for the future
So you've gotten your no-credit auto loan, what's next? We have already seen the components that make up your credit score. And, from that, you can deduce that the most effective ways to improve your future credit score are to:
- Pay all your bills on time.
- Use your cards, but don't let their balances exceed 30 percent of their credit limits.
- Don't open or close accounts unnecessarily.
- Ideally, have a mix of cards and installment loans (but see the previous point).
Additionally, there are some products that can help establish a thicker credit history. Some happen to be an expensive way of borrowing so be sure to use them strategically. This may mean dumping them (though not necessarily closing old card accounts) in favor of mainstream alternatives the moment your improved credit score allows you to do so. And, in the case of plastic, it means zeroing your card balances every month. Those products include:
- Secured credit cards – These require a down payment, which is normally your credit limit. So you are paying to borrow your own money! But these can quickly elevate your credit score.
- Store cards – These are often easier to get than mainstream credit cards, but you will likely need some sort of score. So maybe apply after some months of on-time payments on your auto loan and secured plastic.
And don't forget your auto loan – Yes, your auto loan can put you on the fast track to a better score in the future.