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Using Car Loans as a Tool to Repair Bad Credit

Using Car Loans as a Tool to Repair Bad Credit

Bad credit can be a frustrating and stressful situation. A low credit score resulting from missed payments, defaults, or excessive debt can prevent you from qualifying for loans, credit cards, mortgages, and other financial products. Without access to credit, it can be very difficult to make major purchases like buying a house or car.

Fortunately, there are ways to rebuild and repair your credit over time. One strategy is to take out an auto loan and make payments responsibly. Successfully paying off a car loan can demonstrate to lenders that you are committed to honoring your financial obligations.

In this comprehensive guide, we’ll explore how to use car loans as an effective tool for improving your credit score. We’ll cover how to get approved, find the best rates, budget properly, and manage your payments. We’ll also provide tips to ensure your auto loan helps rather than hurts your credit. With some discipline and financial prudence, a car loan can put you back on the road to good credit.

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What is Bad Credit?

Bad credit refers to credit scores that fall below 670 on the FICO scale. This score is considered poor or below average by most lenders. Having a credit score under 670 will make it difficult for you to qualify for loans, credit cards, mortgages, and other lines of credit.

Lenders view borrowers with credit scores below 670 as riskier applicants. Data shows that people with lower credit scores are more likely to miss payments or default on loans compared to those with very good or excellent credit. As a result, you’ll have a tougher time getting approved if your score falls in the bad credit range.

With bad credit, you may face higher interest rates, more fees, lower credit limits, and less favorable loan terms. You may not qualify for the best mortgage rates or the 0% financing deals offered to consumers with excellent credit. Having bad credit will make major purchases more expensive over the long run.

The good news is that you can take steps to rebuild and improve your credit score over time. Using a car loan strategically and responsibly making payments is one potential way to boost your credit if it’s currently damaged.


How Credit Scores are Calculated

Your credit score is calculated based on several factors related to your credit history and current credit situation. Here are some of the main components that make up your score:


Payment History

Your payment history, which shows whether you’ve paid bills and debts on time, is typically the biggest factor in your credit score. Payment history makes up 35% of your FICO credit score. Late payments will lower your score, while a track record of on-time payments will help raise your score.


Credit Utilization

This measures how much of your available credit you are using. Owing a large proportion of your credit limit will lower your score. Experts recommend keeping credit utilization below 30%. This factor makes up 30% of your FICO score.


Length of History

The longer your credit history, the better. Your score considers the age of your oldest account, the age of your newest account, and the average age of all your accounts. Having a longer credit history demonstrates you can responsibly manage credit long-term.


New Credit

Opening several new credit accounts in a short period can lower your score temporarily. However, responsibly managing new credit and letting it age can ultimately strengthen your credit mix and improve your score over time.


How Car Loans Can Help Credit

One of the main ways a car loan can help improve your credit is that it’s an installment loan that gets reported to the credit bureaus each month. Installment loans like car loans, mortgages, and student loans are different than revolving credit like credit cards. With installment loans, you borrow a set amount and make fixed monthly payments over a defined repayment term until the loan is paid off.

Each month when you make an on-time payment on an installment loan, it gets reported to the three major credit bureaus – Equifax, TransUnion, and Experian. This provides a record of responsible borrowing and timely payments. As you demonstrate the ability to manage this debt and pay it down month after month, your credit score will gradually improve.

On the other hand, if you miss or make late payments, that also gets documented and your credit score will be negatively impacted. The key is to diligently make at least the minimum payment required each month before the due date. Consistently making on-time payments shows credit bureaus you can handle debt responsibly.


Getting Approved for a Car Loan

Getting approved for a car loan with bad credit can seem daunting, but is very possible if you understand what lenders are looking for. The most important requirements to get a car loan approval with poor credit include:


  • Down payment – Having a down payment of 10-20% of the vehicle’s price increases approval odds.
  • Proof of income – Lenders want to see you have enough steady income to afford the monthly payments.
  • Limited existing debt – Too much outstanding debt from credit cards or other loans will make approval harder.
  • Trade-in equity – Having positive equity in a trade-in vehicle shows you can manage an auto loan responsibly.


When comparing lender options, look beyond just interest rates. Consider:


  • Loan fees – Lower origination fees help reduce the overall cost.
  • Prepayment penalties – Avoid loans with penalties for paying off early.
  • Dealer financing – Manufacturer incentives may provide better terms than banks.
  • Credit unions – Often offer more flexibility for borrowers with poor credit.


Shopping around gives you negotiating leverage to secure the best possible loan terms given your credit profile.


Secured Car Loans Explained


One way to get approved for a car loan with bad credit is to take out a secured car loan. With a secured loan, you provide a down payment upfront that acts as collateral for the lender. Your down payment is usually a percentage of the total loan amount, often 20-30%.

The down payment reduces risk for the lender. If you were to default on the loan, the lender could repossess the car and sell it to recoup the down payment. This added protection means lenders are often willing to offer lower interest rates on secured loans compared to unsecured loans.

Even borrowers with very poor credit scores can qualify for secured car loans. The lender still reviews your credit, income, and debts. But the down payment shows you are committed to paying back the loan responsibly.

Just make sure to compare rates from different lenders. Some will offer better secured loan rates than others. Know your budget, shop around, and don’t take on more debt than you can realistically manage.


Finding the Best Car Loan Rates with Bad Credit


When shopping for a car loan with bad credit, it’s important to compare rates from various lenders to find the best deal. Here are some tips on where to look for loans and how to get the lowest interest rates possible:

Banks and Credit Unions – Large banks and local credit unions are good places to start your search. Even if you don’t qualify for their lowest advertised rates due to your credit, they may offer special loan programs for borrowers looking to rebuild credit.

Dealerships – Many dealerships work with special finance lenders that provide loans to those with poor credit. However, dealer financing often comes with higher interest rates. Shop around for pre-approval from a bank or credit union first, then negotiate with the dealership if they can beat your rate.

Online Lenders – There are online lending companies that cater specifically to borrowers with bad credit by offering higher approval rates. Make sure to compare interest rates and fees from multiple online lenders.

Consider Used Cars – Interest rates are typically lower for used cars versus new cars. Opting for a used vehicle that is a few years old can help you qualify for a more affordable monthly payment.

Setting a firm budget before you start shopping is key. Only apply for a loan amount you know you can manage based on your income and expenses. Avoid taking on too much debt just to get approved.


Budgeting and Managing Payments


Once you’ve been approved for a car loan and purchased your vehicle, it’s crucial to budget properly and manage your payments responsibly. This will ensure you avoid late fees or defaults that could further damage your credit. Here are some tips:

Make a budget that factors in all fees and insurance costs associated with your car loan. Know your total monthly payment amount and plan your budget accordingly. Avoid taking on too much debt that will be difficult to manage.

Enroll in autopay through your lender so payments are automatically deducted from your account each month. This prevents accidentally missing payments if you forget.

Pay more than the minimum amount due whenever possible. Making larger payments reduces your principal faster, saves on interest, and demonstrates responsible money management.

Contact your lender immediately if you anticipate having any issues making a payment on time. They may be able to offer hardship options or payment deferrals to avoid a default.

Stick closely to your budget and payment schedule. Handling your car loan properly is key to improving your credit situation over time.


Maintaining Good Payment Habits

Once you have been approved for a car loan and start making payments, it’s crucial to maintain good payment habits throughout the life of the loan. This will ensure you get the maximum credit benefit. Here are some tips:


Always Pay On Time

The most important habit is paying your monthly car loan payment by the due date every single month. Set up autopay or calendar reminders so you never miss a payment. Even one late payment can negatively impact your credit score progress.


Contact Lender if Issues Arise

If an unexpected financial issue arises that may prevent you from making your full payment that month, immediately contact your lender. Don’t wait until after the missed payment. The lender may be able to work with you by allowing a partial payment or deferring that month’s payment to the end of the loan. But they can only do this if you communicate proactively.


Avoiding Common Mistakes

When taking out a car loan to rebuild your credit, it’s important to avoid some common mistakes that could lead you deeper into debt and worsen your credit situation.


Don’t Take on Too Much Debt

It can be tempting to finance a flashy new car when you get approved for a loan, but avoid taking on excessive debt. Stick to your budget and don’t purchase more car than you can realistically afford based on the loan’s repayment terms. Taking on too much debt increases the risk of missing payments and defaulting.


Read All Terms Carefully

Be sure to scrutinize the fine print and understand the full terms of any car loan. Watch out for high interest rates, hidden fees, penalties for late or missed payments, and other unfavorable conditions. Ask questions if any part of the loan agreement is unclear before signing. Knowing the terms helps avoid surprises down the road.


Improving Credit During the Loan

While having an auto loan and making payments can help rebuild your credit, there are additional steps you can take during the loan term to further boost your score:


  • Use a credit card responsibly – Having open credit card accounts with low balances and on-time payments demonstrates you can manage different types of credit. Using a card lightly and paying it off each month will complement your auto loan in improving your score.
  • Check your credit reports – Review your credit reports from Equifax and TransUnion every few months. Dispute any errors you find so your credit profile is accurate. This ensures your score reflects your true creditworthiness.
  • Limit hard credit inquiries – Applying for too much new credit can hurt your score as it suggests risky behavior. Besides your auto loan, avoid unnecessary credit applications while rebuilding credit.
  • Ask for credit limit increases – As you demonstrate responsible credit usage, you can ask issuers for higher limits. Higher limits with low balances boost your credit utilization ratio.
  • Become an authorized user – You can benefit from another person’s good credit history. Ask a family member with strong credit to add you as an authorized user on their credit card.


Leveraging techniques like these during your auto loan can accelerate your credit repair efforts. Check your score periodically to monitor your progress.


What Happens After Payoff

After you successfully pay off your auto loan, your credit score will continue to benefit in a few key ways:

Credit mix improves – Having an installment loan like a car loan paid off looks good in your credit mix. Lenders want to see you’ve managed different types of credit responsibly, not just credit cards. Having an auto loan paid off shows you can handle this type of installment loan.

Open a new credit account – Don’t rest on your laurels after paying off your car loan. This is a good time to consider opening another credit account, like a rewards credit card, to further build your credit. Having a new account helps show lenders you continue using credit responsibly after paying off your auto loan.

The positive effects of paying off your auto loan can last for years. But you need to continue practicing good credit habits, like paying all bills on time and keeping balances low. With diligence, your credit score can continue improving long after your car loan is paid off.


Other Ways to Rebuild Credit

While a car loan can be an effective strategy, there are other options for rebuilding damaged credit as well. Two additional methods to consider are secured credit cards and credit counseling.


Secured Credit Cards

Secured credit cards require an upfront security deposit that acts as your credit limit. The deposit shows lenders you have “skin in the game” and lowers their risk, making approval easier for those with poor credit.

Like a regular card, you’ll make monthly payments and your activity gets reported to credit bureaus. Paying on time and keeping your utilization low demonstrates responsible usage and can quickly boost your score.

Just be sure to avoid high fees, read the fine print, and make more than the minimum payments to see results.


Credit Counseling

Non-profit credit counseling agencies can provide guidance on managing debt and repairing your credit. They offer services like debt management plans, budgeting help, and financial education.

Counsellors can negotiate with creditors to lower interest rates and create a consolidated payment plan. This can make paying off debt easier and faster.

The key is finding an accredited agency that charges reasonable fees. Legitimate counselors should help you understand your full financial picture and provide customized advice.



In conclusion, car loans can be an effective tool for repairing bad credit if used strategically. The key points are:


  • Car loans help build credit history by reporting monthly payments to credit bureaus.
  • Making consistent on-time payments demonstrates you can handle debt responsibly.
  • Late or missed payments negatively impact your credit score.
  • Compare loan rates and know your budget to avoid taking on too much debt.
  • Enroll in autopay, pay more than the minimum, and contact the lender if issues arise to manage the loan responsibly.
  • Your credit will gradually improve as you make timely payments over the loan term.


While getting approved with bad credit can be challenging, car loans remain an accessible option. By comparing lenders, understanding all fees, budgeting properly, and making payments on time, you can use a car loan to rebuild and repair your credit score over time.

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Questions About Using Car Loans to Repair Bad Credit

Getting a car loan with bad credit in Canada can be a useful tool for rebuilding your credit score over time. When you make your monthly car payments on time, it demonstrates to lenders that you can responsibly manage credit. Just be sure to only borrow what you can reasonably afford to repay on the loan. Shop around for lenders that offer bad credit car loans at reasonable interest rates. Avoid predatory lenders that try to take advantage with excessively high rates.

Most mainstream lenders in Canada typically require a minimum credit score in the range of 600-650 for approval on a standard car loan. Borrowers with scores under 600 are generally considered subprime and may need to look for special financing programs aimed at bad credit applicants. With very poor scores below 500, it becomes quite difficult to get approved for a car loan from a traditional lender no matter what the terms.

If you make consistent on-time payments, it typically takes about 12-24 months before you’ll see a significant benefit to your scores when using a car loan to rebuild credit. After about a year, you should be able to refinance the loan potentially at a much lower interest rate thanks to the improved credit. Just keep in mind, missing payments can quickly ruin all the progress made, so be sure to only borrow what you can realistically repay on a monthly basis.

For borrowers with poor credit below 600, it’s typical to see interest rates between 10-20% at most subprime lenders that offer car loans to high risk applicants in Canada. Rates over 20% enter very high risk territory. Compare rates from multiple subprime lenders carefully because even a few percentage points can make a big difference on a 5-6 year car loan.

Most subprime lenders in Canada will offer maximum loan terms of 4-6 years for borrowers with poor credit. A few may stretch loans out as long as 8 years, but keep in mind, the longer the term, the more interest you pay over time. Avoid ultra long 7-8 year loans whenever possible, even if that lower monthly payment seems enticing upfront. You’ll save substantially choosing shorter terms if you can afford the higher payment.

The very first thing to do is thoroughly check your credit reports and fix any errors dragging down your scores. Then pay down balances on revolving credit cards to decrease your credit utilization ratio. Having a trusted co-signer with good credit co-apply on the car loan can also help obtain more reasonable interest rates. Bringing a larger down payment of 15-20% or more can also incentivize subprime lenders to offer the lowest rates they reasonably can. Shop around extensively and negotiate!

Most subprime lenders want to see your total monthly debts divided by gross monthly income below 40-45% before they will approve bad credit car loan applications. The lower the ratio, the better the terms and rates offered generally. If your ratio is too high above 50%, it makes the loan look overly risky on paper and will cause denials or require an eligible co-signer. Pay down other debts or increase income to get the ratio into a more acceptable zone.

Used car lenders view loans as less risky when borrowers put more money down upfront, especially important for approval when you have bad credit. Putting down 20-30% or more on a used vehicle purchase often allows subprime lenders to offer the very best rates they can provide. Smaller down payments around 10-15% may still get approved but likely at higher interest rates. Exceptionally small down payments often receive denials.

Nearly all subprime lenders will ask for recent pay stubs, bank statements, tax returns, a driver’s abstract, proof of insurance, proof of address, references, and source of down payment documentation. Be prepared to provide a detailed budget breakdown as well. The more financial documentation provided upfront, the easier it is for a lender to fairly assess the loan risk to potentially offer an approval decision.

Yes, there are some subprime lenders that will work with borrowers receiving social assistance payments, disability benefits, or pensions – granting car loan approvals primarily based on ability to afford the payments each month with the fixed assistance income. Approval chances increase when bringing a down payment from savings and showing the reliable government aid coming in monthly.

Bring in a qualified co-signer with good established credit, make a larger down payment if at all possible, provide extensive financial documentation upfront, consider including a GPS tracker or starter interrupter device to secure the lender’s asset, shop for older cheaper vehicles that require smaller loan amounts, explain any past credit issues demonstrating changed circumstances, build rapport directly with the finance manager at the dealership. These all significantly boost your chances.

Yes absolutely. When you fail to make payments on a subprime car loan in Canada as agreed upon in the contract and become delinquent, the dealership has legal authority to hire a repossession company to retrieve the vehicle after a certain period of time, usually between 2-3 months of no payments. This repossession remains on your credit history for years severely damaging your score.

You can try to get the vehicle back during the redemption period by paying the full outstanding loan balance including all late fees and repossession costs in cash. If unable or unwilling to do so, you can voluntarily surrender it saving further costs. Be aware a repossession stays on your credit report for 7 years. You will still owe remaining loan deficiency balances and collection costs. New vehicle financing will be extremely difficult afterwards.

Yes, certain vehicles tend to work better for subprime approval because they represent lower risk investments for lenders while still meeting most driver needs. Compact sedans and older used models of Honda Civics, Toyota Corollas, Mazda3s, and Hyundai Elantras are common starter choices. Avoid newer luxury brands or trucks unless they meet specific work needs. Stick to basic transportation.

Once your credit score is reestablished into the good range over 700 after diligently making payments on time and keeping balances low, you can expect to see interest rates around 4-8% at most mainstream used car lenders when financing another vehicle. This saves thousands of dollars in interest costs over the lifetime of the loan compared to the double-digit rates from when your score was lower.

Yes, an eligible consigner with a long credit history and scores above 700 can drastically improve the chances of a subprime car loan approval in Canada even with bad credit. The cosigner must have sufficient income to cover the payments if you happen to default. Their good credit essentially overrides your scores when deciding on loan decisioning. Just make sure to repay as agreed to avoid burdening the consigner.

Having a repossession within the last 2-4 years makes getting another car loan extremely difficult in Canada. Most lenders will automatically decline applications for years after a repo. Your best chance is rebuilding credit slowly with secured cards and saving up a large down payment of 30-50% on a beater vehicle. Expect to pay interest rates above 20% even still when finally approved post-repossession.

Yes. Whenever possible, voluntarily surrendering your financed car to the lender instead of forced repossession will show up in a slightly less damaging way on your credit record in Canada. Repossession indicates a complete failure to cooperate with the lender. Surrendering shows a bit more financial responsibility reducing impact on your future borrowing ability.

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