Despite an economy on the upturn, many Americans are finding bankruptcy to be the only answer when financial circumstances overwhelm them or a job loss or illness turns a rosy future into a disaster. Bankruptcy gives some time and breathing room to pay off debts, or it may expunge those debts altogether. But bankruptcy is not a financial Get out of Jail Free card. It has consequences, and one consequence is that it will make it more difficult-and more expensive-to get a new loan for a big-ticket item such as a car. Happily, you can recover from bankruptcy, rebuild your credit, and rejoin the economic mainstream. So how does buying a car figure into the equation?
Buying a vehicle makes sense after bankruptcy if you treat it as a tool to improve your financial situation. Buying a car or truck after bankruptcy makes no sense at all if it causes you to overextend your finances by putting you in a situation where making your loan payments is a struggle-or worse. Buying a vehicle that is too expensive or buying one too soon after bankruptcy won’t help you, and it could send you hurtling back over the financial abyss. But by very carefully obtaining an auto loan with terms you can handle, you can begin to re-establish your creditworthiness. “If someone [after bankruptcy] can be approved for a car loan and makes the payments on time every month, the loan will help them re-establish credit,” Sarah Teets, a senior client advocate at credit-counseling firm GreenPath Financial Wellness, told C/D.
Chapter 7 and Chapter 13
There are two types of personal bankruptcy in the United States, and each type has ramifications for a potential vehicle purchase. In a Chapter 7 bankruptcy, the court liquidates your assets and distributes them to your creditors, and your debts are essentially expunged. Quite often, certain assets are exempted from the liquidation up to a certain value. A vehicle can be one of those assets, because bankruptcy courts generally recognize that one needs a car to get and keep a job. The entire Chapter 7 process is relatively short, typically less than six months. After receiving your Notice of Discharge, you will be debt free, but you will also have a bankruptcy on your credit report, where it will stay for 10 years, Teets said. This will typically drop you into the riskiest and most expensive end of the car-loan pool: subprime.
Chapter 13 bankruptcy is substantively different than Chapter 7. In a Chapter 13 bankruptcy, debt is restructured, not discharged. The good news is that you save your assets rather than seeing the vast majority of what you own liquidated to pay off debt. The bad news is that it is a lengthy process than can take up to five years. During that multiyear period, taking on substantial additional debt isn’t your decision alone; it also requires the permission of the bankruptcy court. “One thing the bankruptcy trustee will consider is whether a [new] car should be regarded as a necessity or a luxury,” Teets said.
Permission to take on a car loan to buy a modest vehicle often is granted by the court. But just as is the case for the person who has filed Chapter 7, the Chapter 13 bankruptcy will be a black mark that will stay with you, typically for seven years. It also will label you a subprime loan prospect.
Car Buying Choices Post-Bankruptcy Should Be Modest
Subprime buyers are getting car loans and purchasing new cars every day of the week. The important question isn’t whether you can buy a vehicle; it is whether you should buy one. If you take on a subprime loan, the odds are that you will be charged an interest rate three to four times higher than that charged to those with the best credit scores. While car-loan interest rates for the least risky buyers currently hover around 4.0 percent, the Associated Press recently reported the rate for subprime borrowers has ballooned to 16.84 percent.
Still, accepting a loan at a high rate can be beneficial if you buy an affordable, reliable vehicle that will help your employment situation. Purchase a modest, used “transportation car” that won’t cost you more than 15 percent of your total take-home pay. Save the purchase of the brand-new car until you have put your financial house in order and bankruptcy is long behind you.
Sadly, though, many consumers emerging from bankruptcy can’t resist that brand-new, flashy set of wheels. And some car dealers take advantage of those people by offering them financing, often at exorbitant interest rates, knowing full well they are likely to default on the loan. If they do, the vehicle will be repossessed, and the money the car buyer has paid on the loan will be forfeited. The car buyer ends up with no car and no money, a financial double whammy.
Here are quick tips on car buying after bankruptcy:
1. Repair Your Credit
Chapter 7 bankruptcy should discharge your debts, but you should check your credit reports to make certain this has occurred. If some of the accounts that should have been closed by the bankruptcy are not closed, that will wreak additional havoc on your credit score. If you see issues, get them fixed.
2. Re-Establish Your Credit
If you have outstanding loans that have survived the bankruptcy, be certain you are meticulously making the payments on time. Get a secured credit card that requires a cash deposit and is commonly used to rebuild credit. If you make on-time minimum payments and maintain the account balance below the credit limit on the secured card, you will improve your credit rating. Proceed in this manner for at least a year before seeking to buy a car on credit.
3. Shop, Shop, Shop for Your Car Loan
Prospective buyers with a bankruptcy on their credit history will often be confronted with extremely high interest rates, but those interest rates can vary widely. If you have a good relationship with your bank or credit union, start your search for a car loan there.
4. Set Your Sights on a Reliable, Inexpensive Vehicle
Because of your bankruptcy history, you will be facing higher than average interest rates, so it is a poor financial decision to make the purchase even more expensive by considering a high-priced new car. As you rebuild your credit, your emphasis should be on modest transportation.
5. Make Your Payments on Time
Once you have purchased a vehicle, be certain you make your payments on time. Don’t give the dealer and/or the financial institution a reason to consider repossessing your vehicle. That would leave you without transportation and in worse financial straits than you were before the purchase.