If you're trying to buy a car but you have no credit history, take solace: You're not alone. About 26 million Americans are "credit invisible," and another 19 million Americans have at least some credit history, but their files are so thin or outdated they're considered "unscoreable."
If you're in one of these categories, your car financing options can be pretty narrow. For most people, your available choices consist of the following:
- Save Money and Pay Cash
- Get a 'Subprime' Auto Loan
- Go to a 'Buy Here/Pay Here' Dealer
- Build Credit and Qualify for a Better Loan
And once you've purchased a car, keep this in mind: There are certain challenges to buying insurance with no credit history. Learn more about how to buy a car and find the best car insurance rates without credit.
Save Money and Pay Cash
If you have time, of course, the best long-term option is to wait and pay cash for a car. After all, the best auto interest rate is 0%. And if you have cash, you can buy from a private seller, who might give you a much better price.
Of course, not everyone has that option. If you need a car to get to work or school or run your business, and you don't have thousands in cash on hand, you'll need to finance.
Get a 'Subprime' Auto Loan
If you need to buy a used car immediately and you don't have any credit history, any financing you can get is probably going to be in the subprime market. Subprime and no-credit applicants, those considered to be higher risk, routinely pay higher interest rates than those with established credit histories. This is because default rates are high—8 percent in the subprime car market last year and climbing. Expect to make a higher down payment and pay a higher interest rate than other borrowers. Subprime borrowers are paying an average interest rate over 16 percent. If you're buying an older car or one with high mileage, expect to pay even more.
Choosing the Car. Generally, the older the car, the bigger the required down payment. Subprime lenders may require down payments of 20 percent to 30 percent. And banks and credit unions may not be willing to lend on cars older than 10 years or above certain mileage thresholds.
Tip: Look for a loan that has no prepayment penalty. As your credit improves, you may want to refinance your loan, which could potentially save you hundreds of dollars per month.
Getting preapproved for a loan before you go to the dealer helps you know how much car you can buy, and it improves your bargaining position with the seller.
To get preapproved for an auto loan, make an appointment with your bank or credit union's branch or credit manager, and apply at their desk. If you have no credit history or very limited credit history, your bank finance manager can tell you where you stand. Even if you get turned down for a car loan, your banker may help you get a "starter" loan, credit card or other credit-building tool.
You'll also form a relationship with the banker. For these reasons, it may be better to apply in person—even if your bank or credit union lets you apply online.
What You'll Need
Bring the following documents to the bank or credit union:
- A recent pay stub from your employer, ideally showing year-to-date earnings.
- If you're self-employed or have irregular income, bring three months' worth of bank statements showing deposits and expenses.
- Phone bill and other utility bills.
- References from lenders or employers.
Tip: Banks and credit unions tend to prefer financing newer cars, and they may be reluctant to finance cars that are more than a few years old. If you're looking for a low-cost older used car or a car with higher mileage, you may have more success from a specialty auto lender. You can also check with your car dealer's finance department, which often has a working relationship with many different lenders.
Even if your bank or credit union turns you down, you can get some insight from your banker on what you need to do for a future application.
Go Through a Dealership
Franchise dealerships contract with specific car manufacturers such as Toyota or Ford. Their new cars are generally all from the manufacturer they've franchised with, but the used cars can be from any manufacturer.
All of these large branded dealerships have their own in-house finance departments. Their job is to help you get approved for a loan, if possible. They may have relationships with a dozen or more different lenders, and they want you to get approved.
Lenders at these dealerships generally prefer to lend on new cars or at least ones that are less than eight years old.
First-time Buyer Programs
Manufacturers and dealers know that young customers have the greatest lifetime value, and if they make the car-buying experience positive for first-time buyers, they have a good chance to earn that customer's loyalty for many years to come.
Some dealerships will advertise "first-time buyer" programs that reduce down payment, credit history and income requirements. Some dealers will "match" your down payment to make it easier to get into a car (usually by adding the amount ‘matched' to the loan balance).
Generally, to qualify for a first-time buyer program, you'll need to prove you have had a full-time job for three to six months, and you'll need to make a minimum down payment, typically around $500 to $1500, depending on the program and the car.
Generally, newer cars have lower down payment requirements, but your monthly payments will be higher.
Get a Co-signer
If you have a co-signer with established credit, you can get the benefit of their strong credit history. If their credit is very good (e.g., their FICO credit score is 700 and above), you could qualify for a great deal.
Here's the downside. If you can't make the payments, the co-signer is on the hook and their credit score may suffer if any payments are missed.
Again, you'll want to show up with some documentation:
- Your driver's license.
- Loan preapproval, if any.
- Recent pay stub. If you're self-employed, bring at least three months' worth of recent bank statements or other proof of income.
- Cash or proof of funds for a down payment and other expenses. These may include dealers' fees, tax, tags, title and license.
- Names, phone numbers and addresses of references.
Go to a 'Buy Here/Pay Here' Dealer
A car that costs less than $7,000 could be difficult to finance, so you might try a small "buy here/pay here" dealer. These are also known as "tote the note" shops, in which the seller will extend you credit to buy a car. At these dealers, you'll make a down payment and agree to drop off a weekly or monthly payment at the dealer's office.
The seller will typically charge a high interest rate—for example, 30 percent—and may or may not report your payment activity to credit bureaus. Dealers are also quick to repossess your car if you miss a payment or two. If you're trying to build credit, you're usually better off with a lender that reports your on-time payments to the credit bureaus.
These lots may not run a credit report—they mostly want to verify you have a source of income and an address. If you can prove both of these things, you'll probably qualify for their credit standards. Many people go to buy here/pay here dealers as a last resort after getting turned down by traditional lenders.
Build Credit and Qualify for a Better Loan
If you're starting the car-buying process with no credit, give yourself as much lead time as possible. The ability to walk away from a deal is your ultimate negotiating tool. If you wait until you absolutely need to buy a car right away, you'll paint yourself into a corner. You'll have a stronger negotiating position if you give yourself more time.
Meanwhile, here are some things you can do build your credit file.
Save Cash. Lenders won't finance the entire cost of a used car. They almost always have caps on the percentage of the car's price they are willing to finance, especially on older cars. So it will be easier to finance a car when you have cash on hand to make a down payment.
Check Your Credit for Mistakes. You can get a free credit report each year from each of the three major consumer credit bureaus (Experian, Equifax and TransUnion). If your report has wrong information, dispute the error with the credit bureau. If your creditor can't prove the information is correct, the credit bureau will remove the error from your record.
Start an Alternative Credit File. Some companies will work with your landlords, fitness clubs and other monthly billers to build a credit file using information that may be invisible to the traditional credit-scoring world. For example, companies like Ecredable and PRBC will track your payment history with these vendors and even put together an independent credit score using data lenders can access.
Get a Cellphone Account. Telephone companies can report your bill-paying habits to credit bureaus, so it's important to make these payments on time.
Get a Credit Card. You can build your credit history with a credit card without paying a dime in interest. Charge routine bills to the credit card, and pay off the balance in full each month. You'll benefit from points or cash-back rewards the card offers, too. The card issuer will report your payment every month to the consumer credit bureaus, which will help you improve your credit and get a better car loan.
What Does it Take to Qualify for a Car Loan?
Whether or not you have a scoreable credit history, lenders will want to know your debt-to-income ratio, or DTI. This is simply a way of comparing your monthly debt obligations to your monthly pretax income to see if you can handle more debt.
If you have bad credit or no credit, your DTI ratio takes on extra importance. In fact, if you have no credit or an unscoreable credit history, your DTI ratio is the only factor lenders can see.
Every lender is different, but generally, they want a debt-to-income ratio (including your new auto loan) that's less than 40 percent of your income. Experience shows lenders that default rates increase among customers who extend themselves beyond that point. For consumers with bad or no credit, lenders may decline loans that would put the DTI above 30 percent.
Example: You have no credit and a monthly income of $5,000 before taxes. Your rent, student loans and other commitments total $1,200 per month. That puts you at a DTI of 24 percent. If your lender has a DTI "cap" for no-credit borrowers of 30 percent, you could potentially qualify for a $300 monthly payment. That would bring your total monthly obligations to $1,500, which is 30 percent of your $5,000 income.
Some lenders will limit your allowable payment to 15 percent of your monthly income—especially if you have a lower income. So if you're making $2,500 per month, you may qualify for a payment of $375 at the high end.
You can improve your debt-to-income ratio, and thus your car-buying power, by reducing your monthly bills or increasing your income. Either way, reducing your DTI can increase your ability to qualify for a loan.
Buying Auto Insurance with No Credit
Auto insurance rates depend on several factors aside from just your driving history such as your age, the city you live in, the car you purchase and even your occupation. Your credit score is one of the factors that, depending on your state, can significantly impact your premiums.
Not all states allow insurance companies to use credit scores when determining car insurance prices. But in states that do allow it, many insurers will use this information when setting rates. In New York, for example, our research found that a driver with poor credit would pay 105% more than a similar driver with excellent credit.
To find the best rates, we recommend comparing auto insurance quotes from at least three insurers in your state. In addition, you can do the following to lower the premiums.
Increase Your Deductibles. Certain types of auto insurance coverage, such as comprehensive and collision, come with deductibles. Your deductible is the amount of money you would have to pay out of pocket before your insurance pays for damage. By increasing the deductible, you'll pay lower premiums. Just make sure you have the funds to cover the deductible in case you have to use it.
Take Advantage of all Discounts. Some discounts are applied immediately to your policy, such as those available for drivers who haven't been in recent accidents. However, there are some that only apply if you make certain moves—such as telling your insurer that your vehicle has certain safety features or by bundling policies. There are also discounts available with most major insurers if you sign up for a telematics program, which tracks your driving and lowers rates for good driving habits.
Consider When You Need to File a Claim. Insurers consider your claims history when determining prices. So, if there's a minor issue you can pay for out of pocket, it may be better to handle the cost yourself. A clean claims history can help keep rates reasonable.