Buying a New Car When You Have Bad Credit

Do you have bad credit? Brand-new credit? If you do, getting a decent car loan can be tough. The good news is that with some guidance and a little patience, it should be possible to secure a fair car loan regardless of your credit situation.

Here are nine tips that will address your bad credit and help you get into a new ride:

1: Prep Early and Know Your Credit Score

You should start with your credit report to see how it would look to a lender. Run it at least three months before you plan on buying so you can take action on any outstanding items, recommends Rod Griffin, director of public education for credit reporting company Experian.

Annual Credit Report.com gives you one free report a year from each of the major credit bureaus:Experian,Equifax andTransUnion. Take advantage of it. Do your best to pay off any credit cards or outstanding loans. Or at least make a payment to show positive activity on the account.

Many credit card companies offer credit monitoring services to their customers. Mobile apps from Credit Karma, Mint and Experian will also show your credit score if you've signed up for their service.

Once you get the free credit report, pay close attention to the section that points out potentially negative items, also called risk factors. Risk factors could be anything from an old debt that went to collections to a fine you had to pay in a civil court case.

Rather than viewing them as blemishes on your credit, "these risk factors can empower you as a consumer to help rehabilitate your credit," Griffin says. The risk factors are present in all reports, so if you fix an issue you found on one credit report, the action will be reflected on all the other reports.

Use the chart below to determine your credit tier, based on your credit score. Your credit score will drastically affect the interest rates you will be offered at the dealership or credit union:

Here are the approximate interest rates you can expect in the nonprime to deep subprime markets. In general, you will see higher interest rates on used cars. New cars tend to have lower rates, but new cars obviously cost more.

New-Car Loan:
Nonprime: 7.1 percent
Subprime: 11.4 percent
Deep subprime: 14.1 percent

Used-Car Loan:
Nonprime: 10.4 percent
Subprime: 16.9 percent
Deep subprime: 19.8 percent

With a good idea of the rates you'll be offered, you can now start shopping.

2: Determine What You Can Afford

Most of us have a rough idea of what we can afford for a monthly car payment. But focusing too much on the monthly payment ignores the bigger picture. You need to save room in your budget for fuel and insurance costs, the latter of which tends to be more expensive if you have poor credit.

If you're on a tight monthly budget, shopping for a used car will likely make the most sense, even when factoring in the lower interest rates offered on new cars. When you look at car prices on the lot, it is important to understand how the bad-credit interest rates will affect the total cost of the auto loan and the monthly payment.

For example, if we use the average interest rate received by each group of borrowers with credit scores below 660, here's how those numbers work out in real life for a $17,000 used car with a 66-month auto loan:

• Nonprime: 10.4 percent APR = $340 per month
• Subprime: 16.9 percent APR = $398 per month
• Deep subprime: 19.8 percent APR = $425 per month

It's clear that if you're a deep subprime borrower looking for a $300 monthly payment, an auto loan for a $17,000 vehicle is more than you can handle. If you had your heart set on buying a car in that range, you'd either need to save up $5,000 to get your loan amount down to $12,000 — which, at 19.8 percent interest, amounts to a monthly payment of about $300 — or look for a less expensive vehicle.

"We love our leather seats and sunroofs," says Griffin, "but when your credit isn't stellar, it is better to look at a lower-end automobile."

Understanding this reality before you start shopping will do more than help you save time. It will also save you the frustration of looking at cars that don't fit your budget. If you're not sure how to figure out your price range, read "How Much Car Can I Afford?"

3: Get Your Financial Documents in Order

Before applying for your loan, have your paperwork in order. Lenders may need to see pay stubs or W-2 or 1099 forms to prove income. If you're in a line of work in which it's hard to prove income — if you're a restaurant server who has a lot of income in cash tips, for example — bring in bank statements that show a history of consistent cash deposits to your account. Some lenders will accept bank statements in place of, or in addition to, standard pay stubs.

The lender might want to see your name on a utility bill, rental agreement or mortgage statement that also shows your current address. Some banks may also accept cellphone bills. The lender wants to know where you live for a couple of reasons. First, it shows stability. A borrower who has lived at the same address for 10 years is likely to stay put, and banks like stability. The second reason is that the bank wants to know where to send the tow truck if the borrower stops paying and the vehicle needs to be repossessed.

Bring recent documents. The lender will likely want to see proof of residency and income that are no more than 30 days old. Having these documents in hand when you arrive at the dealership can mean getting a loan response in a few hours instead of a few days. In addition to documents, some lenders will ask for personal references. When requested, the lender will want names, phone numbers and addresses.

Pro tip: Bring a copy of your credit report with you to the dealership. Having it available might help the dealership skip running your credit, which it would need to do to give you a ballpark idea of the approval you'll be offered.

If you have a co-signer, have his or her information on hand, too.

4: Get Preapproved for an Auto Loan

Now it's time to get approved for a car loan. Make sure to seek approval from more than one lender. Because while your poor credit might bind you to a high-interest rate, some auto loan rates could still be better than others.