A customer with a poor credit history is a high-risk proposition to a potential lender. If they are going to consider giving you a loan at all, it is going to be more expensive than the norm.
But how expensive can they really get? Under Australian law, the cost cannot exceed 48% per annum.
If that sounds excessively high, then you can take some comfort in knowing that there are degrees of credit risk, and unless you are right on the edge, it is unlikely to cost that much.
In this article, we’ll discuss how a lender may determine the level of risk associated with a borrower with bad credit and the range of interest rates that may apply.
What Defines Bad Credit
Credit File
Bad credit often starts with a low credit score, but there are plenty of other indicators that could tell a lender you are higher risk than the average borrower.
Your credit file will provide a historical record going back five years and will include key details about your financial behaviour.
The credit score is the headline number, but lenders will also consider:
- The type and frequency of credit enquiries made, whether they were approved or not.
- Any current loans that have previously been in arrears.
- Formal defaults or credit-related court judgments (these are very bad!).
- Your combined credit card limit and how much of that limit is outstanding.
Generally, a credit score under 500 would be considered low and would limit the number of finance options available to you.
Bank Statement Transactions
If you have a mid to low range credit score, a lender may insist on a closer look at your bank transaction history.
This can provide more context for your current financial discipline.
Some basic examples of both good and bad transactions are below.
Positive transaction patterns:
- Controlled discretionary spending
- Account balance stays at a healthy level throughout the pay cycle.
- Consistent income
Negative Transaction Patterns:
- A balance near zero soon after payday
- Frequent ATM withdrawals
- Gambling transactions
- Wage advance deposits and repayments
- Payment reversals
If many of those negative patterns stack up, it can turn a good credit score into a footnote and an instant rejection of your application.
If you are concerned that you have triggered some of these red flags, then get in touch with our broker team before you apply for your next car loan.
We can conduct a preliminary assessment to ensure that you are placed with the right lender who will accommodate your situation.
Why Interest Rates Must Be Higher When Your Credit’s Low
All of this data is processed with the sole aim of determining the risk that you will default on your loan repayments.
The higher the risk, the greater the chance of financial loss for the lender. Now, multiply that by 1,000 customers and you know that some of them are not going to repay on time, or at all.
For a lender to stay in business, they must make a sufficient profit to absorb those losses and still come out ahead.
This may seem unfair at an individual level, but the alternative is no loan at all.
These lenders would not exist if they were not able to operate in this way, and you are only seeking a loan there if you are not eligible for a better alternative.
Other Costs Associated with a Bad Credit Car Loan
Interest rates are only part of the total cost of a car loan. If you have poor credit, then there are other fees that may be added by the lender, such as:
- Risk Fee
- Establishment Fee
- Higher monthly fee
When combined, these could add another $1,000-$4,000 to your loan, depending on the amount you plan to borrow.
However, if you combined the interest rate and associated fees, then this cannot exceed a 48% annual percentage rate in accordance with Australian law.
This includes any broker fees payable. Any cost associated with the provision of credit must be included in this calculation.
What Are the Average Interest Rates on a Bad Credit Car Loan
Your interest rate will be determined by how bad your credit situation actually is. As we covered earlier, there is a long list of variables that contribute to this determination.
The figures below are a general guide and cannot be linked to a single reference point, such as a credit score.
Bad Credit Interest Rate Guidance:
- Mid-range credit (medium risk): 17% – 22%
- Poor credit (High risk): 20% – 25%
- Very poor credit (Highest risk): 22% – 32%
When you add the additional fees, you can be sure that the annual percentage rate on a loan to a very poor credit customer is going to be pushing that 48% mark.
Your maximum borrowings is also likely to be capped at a lower level than your average customer.
I know the cost sounds very high, but when there is no alternative it is the reality until you improve your credit situation.
But remember, most car loans are 3-5 years long. If your situation improves in that time, then you could refinance to a loan on better terms.
Refinance to a Better Rate (Eventually)
Being stuck paying 25% interest on a car loan is often a wake-up call for people to get their credit situation in order.
The good news is that once you start making improvements, you may be eligible to refinance to another lender that offers a lower rate.
The earlier you do this in the loan term, the more you can save.
An easy win is to make all of your repayments on time for your new car loan. No matter what!!
Stay away from payday loans and wage advance services, and over time, you will look like a lower-risk customer.
To learn more about how to improve your bank statement transactions, click here.
Conclusion
Bad credit is a temporary problem if it is managed correctly. If you need a vehicle, then you may be stuck paying higher interest for a period of time until you qualify for a better deal.
The pathway is there if you stick to your loan repayments and remain disciplined in your spending.
Until then, rates in the teens is the minimum you will pay for a bad credit car loan and possibly higher.
