If you’re looking to finance a vehicle but have bad credit, understanding how interest rates work can make a big difference to the cost of your loan. Interest rates for bad credit car loans are typically higher, but by gaining insight into how these rates are determined, you can take steps to minimise the financial burden.

In this blog, we’ll explore the factors that influence car loan interest rates for bad credit, the options available to borrowers, and some tips to secure the best deal possible.

What is a Bad Credit Car Loan?

A bad credit car loan is tailored for individuals with a poor credit score. Your credit score is a numerical representation of your credit history and is used by lenders to assess your creditworthiness. If you’ve had issues like missed payments, defaults, or bankruptcy, your credit score may be considered ‘bad’ by lenders. The result? You’ll be seen as a higher-risk borrower, which leads to higher interest rates on your car loan.

However, bad credit doesn’t mean you’re locked out of securing a car loan. It just means you’ll likely pay more in interest compared to someone with good credit. Understanding the intricacies of how interest rates work and what influences them is essential to managing costs effectively.

How Do Interest Rates Work?

Interest rates on car loans vary based on several factors, such as your credit score, the lender, and the terms of the loan. Lenders charge interest as compensation for providing the loan and as protection against the perceived risk of lending to someone with bad credit. Here’s how interest rates are typically structured for bad credit car loans.

1. Fixed vs. Variable Interest Rates

• Fixed Interest Rates: A fixed interest rate remains the same for the duration of the loan term. This provides stability, allowing you to budget accurately since your repayments won’t change. Fixed rates for bad credit borrowers tend to be higher due to the increased risk, but they offer peace of mind.

• Variable Interest Rates: With a variable rate, the interest rate can fluctuate based on market conditions or changes to the RBA’s cash rate. While these loans may start with a lower rate, there is a risk that the rate could rise, increasing your repayments.

2. Annual Percentage Rate (APR)

The APR is the true cost of borrowing, expressed as a percentage, and includes both the interest rate and any additional fees, such as loan establishment fees. Comparing APRs rather than just the headline interest rate is key to understanding the true cost of your car loan.

3. Credit Score and Interest Rates

Credit scores are provided by credit reporting agencies such as Equifax, Experian, and illion. These scores are used by lenders to determine your credit risk. Here’s a rough guide to how Australian credit scores may impact interest rates:

• Excellent (800+): Borrowers will be offered the lowest interest rates.

• Good (700-799): Competitive rates are still available.

• Fair (600-699): Rates increase, reflecting moderate risk.

• Poor (below 600): Expect significantly higher interest rates.

Borrowers with poor credit will generally find themselves in the higher brackets, meaning higher overall loan costs. However, every lender has different criteria for assessing creditworthiness, so it’s worth shopping around for more favourable terms.

Factors Influencing Interest Rates for Bad Credit Car Loans

Apart from your credit score, other key factors affect the interest rate you’re offered on a bad credit car loan:

• Loan Term: A shorter loan term usually results in a lower interest rate. However, while shorter terms reduce overall interest costs, they require higher monthly repayments.

• Vehicle Type: New cars often attract lower interest rates compared to used cars. Lenders view newer vehicles as less risky since they hold their value better.

• Loan Amount: The more you borrow, the more interest you will pay over the loan’s life. However, larger loan amounts may result in a slightly lower interest rate.

• Down Payment: Making a larger deposit on the car reduces the amount you need to borrow and lowers the risk for the lender. This could result in a lower interest rate being offered.

• Lender Type: Different lenders have different risk appetites. For example, specialist lenders who focus on bad credit car loans may offer more favourable terms, compared to mainstream banks or financial institutions that may apply stricter lending criteria.

How to Improve Your Chances of Securing a Better Interest Rate

While having bad credit typically leads to higher interest rates, there are steps you can take to improve your chances of getting a more favourable deal:

1. Check Your Credit Score

Before applying for a loan, check your credit score through an Australian credit reporting agency. This will give you a clear idea of where you stand and whether any mistakes in your report need correcting. Fixing errors can quickly improve your credit score, making you eligible for lower interest rates.

2. Save for a Larger Deposit

Increasing your down payment can reduce the lender’s risk and potentially lower your interest rate. By financing a smaller portion of the car’s value, you show the lender that you’re committed to the loan and reduce their exposure to risk.

3. Consider a Co-Signer

If possible, ask someone with good credit to co-sign the loan. This can help secure a lower interest rate, as the lender will view the loan as less risky. Keep in mind that the co-signer is equally responsible for the loan, so this arrangement should only be entered into if both parties are comfortable with the responsibility.

4. Shop Around

Lenders, including banks, credit unions, and specialist lenders, all have different criteria for assessing loan applications. Don’t settle for the first loan you’re offered; instead, compare offers from various lenders, as rates can vary significantly. Use online comparison tools to help find a lender that specialises in bad credit car loans.

5. Shorten the Loan Term

While it might be tempting to spread your repayments over a longer period to reduce monthly costs, a shorter loan term will often come with a lower interest rate. Plus, you’ll save on interest over the life of the loan, which can result in significant long-term savings.

The Importance of Finding the Right Lender

Not all lenders cater to bad credit borrowers. It’s essential to work with a lender that understands your situation and is willing to provide fair loan terms. 

At Naked Loans, we specialise in helping people with bad credit secure car loans that fit their needs. Whether you’re looking for a new or used car, we’ll help you navigate the loan process and find an interest rate that works for you. Reach out to us today, and let us help you navigate the world of bad credit car loans.