The simplest way to purchase a new car post-bankruptcy is to pay cash for the vehicle. For most people, this option is only available for inexpensive used cars. And for many, purchasing any vehicle requires at least some financing.
Putting your credit score back together after bankruptcy takes time and hard work. Whether you had to declare Chapter 7 bankruptcy or Chapter 13 bankruptcy, it is still possible to purchase a car. This article discusses how buying a car after bankruptcy can help you get a fresh start with your credit rating.
Filing Bankruptcy and Your Credit Report
Few financial situations damage your credit score like a bankruptcy. Bad credit makes financing a car more difficult. Before purchasing a car after bankruptcy, it is essential to wait until the bankruptcy is either the court has discharged your previous debts or the bankruptcy is closed. Not all debts qualify for a bankruptcy discharge, such as student loans. A new auto lender will consider all of your existing debt payments when deciding whether to issue new credit.
Both Chapter 7 and 13 bankruptcies have long term effects on your credit. A chapter 7 bankruptcy remains on your credit report for 10 years. Chapter 13 bankruptcies stay for seven years.
On a positive note, a post-bankruptcy auto loan can be a vital step to establishing a good credit history. Successful repayment of the loan will make it easier to finance other items in the future or to qualify for a credit card. After a few years of consistent on-time payments, you also may be able to refinance your car with a lower interest rate.
How Bankruptcy Affects Vehicle Financing
Car dealerships, banks, credit unions and other lenders require borrowers with a prior bankruptcy to provide more security than borrowers with good credit. That is because they view these borrowers as a higher risk of default. The additional security generally begins with a larger down payment. Next, expect the car loan to have a higher interest rate. Lastly, the term of the loan may be shorter than traditional loans. A shorter term and higher interest rate result in a higher monthly payment. It also raises the total loan amount once interest is included.
In addition to a higher interest rate, financial institutions may include other requirements for borrowers with a prior bankruptcy filing. For example, lenders may require one or more cosigners. A cosigner is someone, often a family member, who agrees to pay off the loan if the original lender does not make the required loan payments. For lenders, having a cosigner makes default on the loan less likely. It also decreases the likelihood of repossession. For borrowers with poor credit, a cosigner with good credit can result in a better loan rate and more favorable loan terms for their car purchase.
Improving Your Credit Before Shopping for a Car
One of the best ways to improve the loan terms when buying a car is to improve your credit score. Most lenders rely on your FICO score, along with your employment income, to determine interest rates and loan amounts. After bankruptcy, raising your credit score can be slow. However, establishing a good credit history with an unsecured or secured credit card helps show lenders your trustworthiness. A good credit history means making all payments on time, along with regular, but not excess, use of your credit. Even six months of on-time payments can raise your credit score and help lower the interest rate on future loans. For most post-bankruptcy borrowers, credit card interest rates are high. However, paying off the full amount of credit used each month allows you to build your credit score without paying interest.
Whether or not you attempt to improve your credit score, before shopping for a car, try to get pre-approval for an auto loan. Pre-approval allows you to shop with a specific budget and also helps you avoid dealing with predatory lenders or dealers.
When looking for financing, you should start with lenders that are familiar with the positive aspects of your credit history. That can include your bank or credit union. It is especially true if you have a long-standing relationship with these institutions. Lenders who you have a relationship with will be more likely to listen to the circumstances surrounding your bankruptcy. If relevant, provide documents that show your bankruptcy was caused by a major event, such as a medical emergency or loss of employment.
Provide records of your prior on-time payments and how your circumstances have changed since your bankruptcy, such as a higher paying job. The bank or credit union that you direct deposit your paycheck with can quickly verify your employment. If you had a credit card that was paid off and remained open after your bankruptcy, the lender is another potential starting point. After you exhaust those options, then look to the subprime loan market, but proceed with caution.
Predatory Lenders and Dealerships
Some lenders offer subprime loans to borrowers with poor credit or bankruptcy history. These lenders often work hand-in-hand with used vehicle dealerships. Alternately, dealerships offer installment repayment plans financed directly through the dealer. For some borrowers, these are the only financing options. However, they often come with a higher risk to the borrower, in addition to high interest rates. For example, many installment plans from dealers have stricter policies regarding late or missed payments than other financial institutions. That can lead to more frequent repossession than for other financed vehicles.
Most of these types of lenders charge higher interest rates or have other unfavorable terms. Some used car dealers also take advantage of bad credit borrowers by only offering to finance low-quality cars. Such dealers prey on frustrated buyers who cannot qualify for other financing arrangements.
Shopping for a Car
Being realistic about what you can afford is essential, no matter which type of lender you use. Before looking for a car, determine how much you can afford each month, and do not agree to a monthly payment that exceeds that amount. It is also a good idea to check your credit score before applying for a loan. Also, bear in mind that applying for credit with too many lenders can harm your credit score.
Before applying for financing at a bank or dealer, it is best to discuss your specific situation. Most lenders can estimate whether you will qualify for a loan without running your credit if you know your credit score and history. Only apply when it is likely your application will be approved.
If you cannot find approval, it may be best to wait a few months. It may allow you to save for a larger down payment, or to make a few more on-time payments on a credit card. If waiting is not an option and you need a car immediately, expect to pay more at a self-financing dealer or subprime lender. Regardless, it is best to shop around to find the best vehicle available for your financial situation.
Buying a car after bankruptcy typically means paying cash or financing with higher interest rates and less than favorable loan terms. Buyers may also need a cosigner and may be targeted by predatory lenders. Rebuilding credit and receiving pre-approval for an auto loan can make car buying less stressful and result in a better rate for borrowers with a bankruptcy history.