This is a very common question with car buyers and owners.

The answer is yes, you can sell the car, but you must get enough money in the sale to pay off your loan, so that your bank can give you a “clear” title to give to the new buyer. This is where problems often arise. Let’s see how.

If you are upside down

If you are still paying on your loan, you still have an outstanding balance, which might be more than your car is actually worth. This means you are “upside down” and would need additional cash, after the sale, to fully pay off your loan. Loan companies want to be paid in full immediately after the sale. They won’t allow you to continue to make payments on a car you no longer have.

If you are not upside down

If your loan balance is less than the outstanding balance on your loan, then there’s no problem. You get the money from the buyer, use part of the money to pay off your loan and get the title, and put the remainder of the money in your pocket — possibly as part of a down payment on another car.

 How does it work?

Generally, a smart buyer will insist that he go with you to your bank so that he can write his check directly to the bank, have you add your additional cash if you are upside down, get the title immediately, have you sign over the title to him right then and there, and give him the car keys. That way, there are no delays and no mess. Nice and clean and quick.

Summary

So if you want to sell your car when you are still making payments, yes, it can be done. However, if you still owe more than your car is worth, it is much more difficult — and sometimes impossible.

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Having bad credit means that sometime in your past, possibly as far back as seven or ten years, you have had missed or late loan payments, repossessed property or cars, or have declared bankruptcy. You may also have an excessive number of credit cards with high balances. These factors are included in your credit history reports that come from three credit reporting agencies: Transunion, Experian, and Equifax.

Your entire credit history is summarized in a single number, called your credit score. Your score can be different among the three agencies. You can get your FICO credit scores at FICO Scores/Reports .

Your credit score determines if you’ll get approved for a car loan, how much you’ll in interest, how much down payment you’ll pay, and even how much you’ll pay for auto insurance.

Credit score range from 300 to 850. A credit score less than about 680 is generally considered by most lenders to be “poor” or subprime credit.

How Bad Credit Affects You

Very few things in life can have a more devastating effect on your lifestyle than a poor credit score. A low credit score can cost you hundreds or even thousands of dollars per month.

Credit Cards

Most prime credit cards are entirely out of reach to consumers with bad credit. And the few credit cards that are available to them (known as “sub-prime” cards) typically require exorbitant setup fees or recurring monthly fees, offer very low credit lines, often require cash deposits, and in most cases do not even report your positive credit activity to the credit bureaus.

Automobile Financing

If you are making payments on a car, you are probably paying between $5,000 and $9,000 more just for having bad credit. This added interest shows up every month in a higher payment. Take a look.

What to do

Of course, the most important thing to do is start working on repairing your credit. However, you shouldn’t expect instant results. Meantime, you may have accept loan rejections, or having to pay high interest rates and make large down payments until your credit score gets better.

Getting a family member to co-sign with you on your car loan is the most common way to circumvent some of the problems of bad credit. A co-signer is not a co-borrower as a husband and wife might be. The co-signer is only there to make payments if you stop making payments yourself. The loan is yours and remains yours, even if the co-signer has to pay. Getting a co-signer is a great way to avoid some of the problems of poor credit, and gives you some time to build your credit back by making your payments on time.

If you can’t find a co-signer, you can look at buying your car from a dealer who specializes in working with people who have bad credit, such as Drivetime.com. They have over 78 used-car locations around the country and have a wide selection of cars to choose from.

Repairing Credit Yourself

The Fair Credit Reporting Act gives you the right to dispute any and all items on your credit reports that you feel classify as inaccurate, unverifiable, or misleading. If the bureaus can not verify that the information on your reports is indeed correct, then those items must be deleted.

Disputing items on your credit report is easy. Getting results from the credit bureaus is amazingly difficult, complex, and infuriating. It is not a coincidence that the Federal Trade Commission receives more complaints against credit bureaus than any other type of business. Remember, the credit bureaus are primarily interested in protecting their profits. Investigating your challenge consumes these profits. Short of sparking a mass number of lawsuits, the credit bureaus seem to do everything in their power to discourage consumers from making progress in their restoration efforts.

Restoring your own credit is like repairing your own transmission or representing yourself a court of law; it is possible, but you must decide if you are willing to take the time and assume the risks of doing it yourself. Most people get a professional company or attorney to help them. 

Summary

Buying a car with bad credit is possible but your choices may be limited. You could be refused if you credit is bad enough, or you could be required to pay a high interest rate and/or make a high down payment. Getting a co-signer is often the right solution. It not only allows you to get the loan at a good interest rate, but also helps you improve your credit score.

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David, 17, recently graduated from high school, landed a good paying job, and wanted to buy a new car.

His thought was that he would go to his neighborhood Ford dealer where he had been admiring a bright red Focus model that he felt he could afford, and arrange for a convenient loan to pay for it. He could easily get approved for the loan because his father knows the owner of the dealership. 

The car cost $12,000 with discounts and rebates. He thought a 5 year (60 months) loan would be about right because he figured payments to be $200 a month ($12,000 divided by 60 months), which he could easily afford.

David was wrong — in many ways. Let’s see why.

So what’s wrong with David’s thinking?

Age Requirement
First, he must be at least 18 years old  to be legally responsible to sign contracts, including sales contracts and car loan agreements. He would have to show proof of age before signing.

Loan Approval
Second, ignoring the age problem for a moment, car dealers don’t approve loans or make loans, so it doesn’t matter that David’s dad knows the owner of the dealership. Dealers work with banks and finance companies to arrange loans for customers. It’s the bank or finance company who approves loan applications and grants loans. Dealers sometimes “screen” customers as preliminary way to weed out customers who have impossible credit. 

Credit History
Next, having recently graduated and just getting a new job, David does not have an established credit history. He has never had a credit card, department store account, or a loan. The fact that he has a new job doesn’t help if he’s been working less than 6 months.

If he was old enough (18 or older, see above), he could get a family member to co-sign the loan agreement, which would help him get approved. A co-signer would be responsible only if David fails to pay on his loan.

But since David is not yet 18, he can either wait until he becomes of legal age, or he could have his parents buy a car in their name and add him to their insurance policy as the regular driver.

Calculating Payments
Finally, David doesn’t understand how car loan payments are calculated. It’s not a simple matter of dividing the car’s cost by the number of months in the loan.

In fact, it’s a rather complex business math calculation that takes into account a monthly finance charge (interest), that will significantly increase his total cost, especially for loans 60 months long that have higher interest rates than shorter loans. The calculation must be performed with a business calculator or online auto loan calculator.

Length of Loan
Furthermore, even if David were to be able to get the car loan, a 60-month loan is too long for a teenager  who will become tired of his car long before 5 years is up. More than likely, his tastes will change and he’ll get future pay raises that will allow him to afford (want) better, more expensive cars. 

Unfortunately, with such a long-term loan, he’ll be “upside down” for most of the term of the loan, making it financially troublesome to try to sell or trade before the loan is paid off. He may be tempted to trade and have the dealer roll his “negative equity” into a new car, which is not usually a good thing to do.

Other Costs
Further still, we wonder if David has considered the other costs of owning and driving a car. A car’s purchase cost is only a part of the overall cost of ownership. As a young male driver, his monthly insurance costs could easily exceed his loan payment amount. Then there’s gas, maintenance, repairs, tires, taxes, and license fees.

Summary
Unless someone buys a car for David, he should wait until he is at least 18 years old, has a stable income, has an established credit history, and understands how car buying and financing works.

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Until relatively recent times, it was standard for car dealers and finance companies to require at least 20% down payment on the purchase of a car. It was for a good reason.

Because cars depreciate in value from the moment they are driven off a dealer’s lot, a down payment helps offset that rapid decrease in value, which may keep the loan from becoming “upside down.”  It also protects the loan company or bank because, if they have to repossess the vehicle, they have a smaller risk of losing money.

Things are different now
Auto manufacturers and dealers are now very competitive and business must be fought for. They are willing to take risks that were unheard of just a few years ago. In many cases, down payment requirements have been reduced or eliminated altogether, primarily for customers with good credit.

Even if you have good credit, accepting a “no down payment” deal is not wise. Because your vehicle will depreciate in value faster than your monthly payments pay down your loan, you will be upside down for most of your loan term.

So, what is the problem with being upside down?
First, if you decide to sell or trade your vehicle before your loan is paid off, or nearly paid off, you’ll get a nasty surprise. You’ll find that you still owe more on your loan than your vehicle is worth. Maybe thousands of dollars more. You’ll have to find the extra money to pay off your loan.

Second, if your car is stolen or totaled in an accident, your insurance pays only what the car is worth, not what you still owe on your loan, which again, could be thousands of dollars difference. In order to pay off your loan after the accident, you must come up with the additional cash on your own.

How much down payment?
A down payment not only helps you avoid the problems of being upside down, but it also serves to lower your monthly payment. The amount by which it reduces your payment depends on the amount of the loan, the amount of the down payment, the length (term) of the loan, and the interest rate. You can use an auto loan calculator to play around with the numbers to find out the effect of different down payment amounts.

A good rule of thumb is 20% for a down payment. You can take advantage of manufacturers’ rebates, which can be used as a down payment. If you can’t do 20 percent,  do the best you can.

In some cases, especially if you have poor credit, the bank or finance company will dictate how much down payment you must make to get a car loan from them. It’s usually not negotiable. If it’s more than you can pay, try other banks, credit unions, or loan companies.

If you have poor credit, you might consider looking for your car at a dealer such as Drivetime.com, who specializes in working with buyers who have less-than-perfect credit. They have dealerships all over the country.

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You may still be able to buy another car if you are upside down on your previous loan.

There are two ways to go about it.

One way to buy with an upside down loan
You could sell your old car but you will have to add extra cash to fully pay off your old loan. You’ll need to pay off your loan so that you can give a clear title to your buyer. However, coming up with extra cash might be a problem, especially if you are upside down by a large amount. For many people, this solution is not possible.

Let’s look at some other ways.

Another way to buy if you are upside down
You can trade your old car at a dealer and let the dealer pay off the old loan. Sounds easy, but there’s a catch. If your old car is not worth as much as the amount remaining on your old loan, the dealer takes the difference and adds it to the price of your new car. If you are upside down by a large amount, this can significantly raise the cost of your new car. In some cases, a dealer will not allow the entire amount to be rolled into a new loan, which means you must come up with some cash as a down payment.

When you roll part of an old loan into a new loan, it usually puts you right back into an upside down situation, which is usually worse than your old situation. It is a vicious cycle that you would be best to avoid.

The best way to get out of an upside down loan is to simply keep your old car, keep making payments, until you are no longer upside down. Then, you have the option to do anything you want.

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Assuming you’ll buy with a loan, you will want to have a monthly car payment that will fit within your current income, after considering all your other expenses. Don’t make the mistake of buying based on future expectations — a forthcoming raise, a new job, or other potential improvements in your finances. Your expectations might not come to reality and you’ll be stuck with a car you can’t afford. Base your purchase only on current, stable finances.

Debt and Income
Most lenders look at your income and debt, as well as your credit score, to make a decision about how much you will be allowed to borrow, or if you will be approved at all. If your combined monthly debt (credit car payments, rent, etc.), including the new car payment, exceeds about 36% of your gross monthly income, you may not be approved. If a lower car payment will get you in under 36%, then you might be approved but at a lower loan amount.

Shop for Auto Loans
Shop at local banks, credit unions and loan companies for your auto loan. Since the bank or loan company will check your qualifications, you’ll know fairly quickly how much car you’ll be able to afford. This will allow you to go shopping looking at only those cars you know you can afford. Just be aware that each loan application causes a query against your credit history. Multiple auto loan queries within a 45 day period only counts as a single query and lowers your credit score only by a few points. Many people hesitate to shop for loans, believing that each application hurts their score, which is not the case.

Another way to buy is from a used car dealer who finances his own loans. These dealers, such as Drivetime.com, specialize in working with people who have less-than-perfect credit.

Use a Calculator
If you want to begin by doing some of your own affordability calculations, use an online auto loan calculator to play around with various car prices, loan terms, and down payments to find out how much car you can afford, based on an affordable monthly payment.

Don’t Negotiate Payments
One caution: Don’t negotiate monthly payments with a car dealer if you don’t understand how he is calculating that payment. Instead, negotiate car purchase price and let the dealer tell you what monthly payment it produces. If the payment is too high, go back to the selling price and get it lower, if possible. Getting an affordable monthly car payment doesn’t mean you’re getting a good deal on the price of the car.

Other Costs That Affect Affordability
Also don’t forget that you will have other expenses associated with the ownership and operation of your car. One of the most significant is auto insurance. For first time drivers, insurance can be very expensive. Also consider gas, oil, maintenance, annual inspections and taxes.

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The answer? Yes, under some conditions. Let’s explain.

It is a common situation, especially with young people who have never had a loan, never had credit cards, or never borrowed money for a car. Without a history of prior loans and payments, there is no credit history and no credit score, which is the number that represents credit rating.

In fact it is not quite sufficient to simply have a good credit score to get a car loan — or any loan. You may also need to have an established steady income (a job) and no excessive debts. You should have no recent bankruptcies or auto repossessions, which you wouldn’t be likely to have anyway if you have no credit. 

So how is it possible to buy a car with a loan when you have no credit record and no credit score?

Buying a car with no credit is only possible if you pay cash, or if you get a loan from family or friends — or if you have someone who can co-sign with you on a loan. Having a co-signer is the most common way that most people buy a car with no credit.

A co-signer is not a co-owner. The loan is in both names but the car’s title is only in the name of the primary borrower (unless he wants both names on the title, which is typical for a husband and wife). Only if the primary borrower defaults (misses payments, or stops payments) does the co-signer take over. Even then, the co-signer only makes payments. The car still belongs to the primary borrower, even though the co-signer pays. The co-signer assumes no owership or equity in the car, even if they made most of the payments.

It is also important to know that both the borrower’s and co-signer’s credit are affected negatively if neither can make payments and the car is repossessed.

If you have no credit, having a co-signer on your car loan is a great way to build credit and establish a positive credit history for the next time you need a loan to buy a car.  Just make sure you make all payments on time and don’t miss payments. It also helps to get two or three credit cards or department store cards but don’t apply for them all at the same time. Spread out your applications over a period of three months or more. Charge to the cards frequently. Pay off most of your balance each month.  Make payments on time and keep low (but not zero) balances.

If you want to buy a car with no credit, there are some solutions, the best of which is to have a co-signer. Without a co-signer, you are very limited in your options. You could consider a special type of used car dealer, such as Drivetime.com, who has locations all over the country, and provides their own loans to people with no credit or poor credit.

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