Buying a Car after Bankruptcy
Why Not to Get a Car Loan After Bankruptcy
Most people, when contemplating bankruptcy, believe that they'll never be able to buy any car except an old clunker because they won't be able to get a car loan. Indeed, many bankrupt people do choose to buy used cars with cash so they won't be saddled with payments or have to pay higher insurance rates. If that's your decision, then more power to you. It's a fine idea as long as the car won't wind up costing you more in constant repairs than it would cost to take out a car loan.
That's the route I took myself, in fact, until two years ago (not yet five years post-bankuptcy), when I bought an off-lease car using a loan from my credit unit that came in at a little under 5 percent. I recently traded that car back in to the same dealership and bought a brand-new one at 0.0 percent from the car manufacturer, and that's at just a bit over six years post bankruptcy. So what I'm saying is don't lose hope. If you manage your finances responsibly post-bankruptcy, you'll be able to get a good deal on new car loan eventually.
Until two years ago, however, I turned down all the "blank check" car loan offers I received in favor of buying used cars and paying cash for them. I didn't want the payments, and my insurance saving without having to carry physical damage insurance were enormous. I was paying about $33.00 a month for insurance on those old cars.
Why to Get a Car Loan After Bankruptcy
On the other hand, getting a car loan is one of the best ways to rebuild your credit after bankruptcy. Why is that? Well, let me let you in on a little secret: Almost anyone can get a car loan. Seriously. There are even companies who specialize in bad credit car loans. It's one of the easiest loans there is to get approved for.
In fact, you probably will start getting pre-approved car loan offers the same day after you receive your discharge in the mail or possibly even a few days before. Seriously. There are plenty of lenders out there who will happily finance a used car for you. So don't worry: You'll likely start receiving loan offers in the mail from "understanding" lenders who want to "help you get back on your feet" the day your bankruptcy has cleared.
Feed those postcards to the shredder. Really. Just shred them. Go ahead. I'll wait here for you.
You see, here's the problem. Yes, there are lenders who will finance a car purchase for you the day your bankruptcy is final. They're not lying about that. The problem is that most of these lenders are, well, crooks who make loans on crappy cars sold by dirtbag dealerships at Shylock interest rates -- and then act as if they're doing you a favor.
These lenders almost always require that you purchase the car from one of their "preferred" dealerships. These dealers usually became "preferred" by being as crooked and unscrupulous as the lenders themselves, and by being willing to pay the lenders hefty kickbacks. To cover the payola, most of these dealers will jack up the prices on the crappiest jalopies they have taking up space in the lot, and sell one to you with only the minimum state-required warranty. Then they'll tell you that they "don't do this for just anyone," which is reassuring. Maybe they just belong in jail rather than the Tenth Circle of Hell -- the one even Dante couldn't bring himself to write about.
What these lenders and dealerships are doing is feeding off your eagerness to "get back in the game" after your bankruptcy has cleared, and they want to sell you a car and a loan before the giddiness of being debt-free wears off. They also want you to believe that they're the only people around who will lend you money to buy a car, which is utter nonsense.
The fact is that car loans are among the easiest loans to get, because cars, having wheels as they do, are among the easiest things to repossess. Literally anyone can get a car loan.
But here's the thing: Getting a car loan the day your discharge clears will cost you a lot more than it would if you obtained a secured credit card instead, made regular payments on it for six months or so, and then applied for a car loan. You'll also be locked into the loan on that clunker, possibly for longer than the car itself lasts. So again, unless you really, truly, positively need a car today and can't afford to buy a used car for cash, shred those loan offers. If you can just wait for six months, you'll get better offers.
In a nutshell, what I'm saying is that getting a car loan is a good way to start rebuilding your credit. But accepting a loan from lenders who prey upon the recently-bankrupt is the wrong way to go about it.
The Right Way to Get a Car Loan After Bankruptcy
There is a right way to buy a car after bankruptcy. To understand this, let's look at a few characteristics of car loans in general.
Although a car loan is secured debt, it doesn't mean that it's risk-free for lenders. In the event that you default, the lender's going to lose money. Here's why:
- New cars lose a considerable portion of their value (some say as high as 20 percent) the moment you buy them, simply because they're no longer "new" once they've been sold. So if you buy a new car with no money down, the car is already worth considerably less than the loan amount as soon as you drive it off the lot.
- If you default on your car loan, the bank will have to repossess the car. That costs the bank money. Repo men don't work for free. They'll also have to pay to store the car pending auction or redemption.
- Once the car is repossessed and any redemption period has passed, it will be sold at auction, where sale prices usually are much lower than the car's "book value" and will almost certainly be less than the amount you still owe on the loan.
- If there is any damage to the car, the sale price will be even lower, and the bank will lose even more money.
So looking at it from the bank's point of view, car loans aren't as risk-free as some people think. The loan is secured by the car itself, but cars are depreciating assets that are prone to damage. That means that they make for poor collateral and correspondingly higher risk to the lender. On the other hand, most people pay their car loans even if they're struggling to pay other bills, and banks know that, which is why banks are willing to consider people with bankruptcies on their record.
Your chances of getting a car loan from a "normal" lender (as opposed to a "bad credit" lender) will be much better if you do the following before you apply for the loan:
Make Sure You Can Afford a Financed Car
It makes no sense at all to start your recovery from bankruptcy by making a purchase that you can't afford to pay for. So look around and see what kind of payments car dealers are advertising -- bearing in mind that you'll almost certainly have to pay more because you've filed for bankruptcy -- and figure out where in your budget, exactly, that money's going to come from. Then be prepared to explain that to the lender.
Don't discount a new automobile's manufacturer's financing division as a good lending source. These quasi-banks exist for the purpose of helping people to buy the cars their companies make, so they're highly motivated to lend. If you can convince a new car dealership that you have your act together and can make the payments, they may be able to run interference for you with the lender and negotiate a better deal. That's how I got the zero-percent loan on my present car. The financing company offered 4 percent, but the dealership finagled the zero percent because I was a repeat customer and an all-around nice guy.
In addition to the payments, remember that lenders are going to require that you carry "full" insurance on any car that they finance, even if it's a used car. Not only that, but many car insurers do consider your credit record when determining your rates, so having filed for bankruptcy is likely to increase your insurance rates. To be safe, call your insurer (and their competitors) to determine how much your car insurance will be before you sign on the dotted line. Any reputable insurer or agent will be able to run a hypothetical estimate for you. If they won't, then look elsewhere.
Re-establish some sort of credit.
Before you apply for a car loan, obtain one or two secured credit cards, make all your payments promptly, and keep the balances well below the maximum credit lines. This will demonstrate to prospective lenders that you have mastered the concept of how a loan works (that is, that unlike a "gift," you're supposed to actually pay back a "loan").
If you want an even better deal, wait until you can get a couple of unsecured credit cards from reputable banks or credit unions, keep the balances low, and make all the payments on time for at least a year. That will practically guarantee you a decent rate on a car loan, especially if you can come up with 15 or 20 percent of the purchase cost in cash for a down payment.
Research Realistic Vehicle Choices
Your first new car loan after bankruptcy shouldn't be a Maserati. Really. Be realistic.
Consider less-popular car models that still have good mechanical and safety reviews. Many perfectly-good cars never quite catch on with the buying public because, well, they're kind of ugly. Maybe the body designs aren't very "sexy," maybe the color choices are less-than-wonderful, or maybe they've acquired a reputation as cars for old farts. But they're still good cars with good reliability histories.
For someone purchasing his or her first car after bankruptcy, these cars may be godsends. The dealerships really want these cars off their lots, but no one is buying them; so their manufacturers often offer generous rebates as incentives to move them. Dealerships invariably are willing to work extra hard to get you financed if it means getting a car that no one else wants off their lot.
If you decide to buy an unpopular car, make sure that it's not unpopular because of mechanical or safety problems. Look for good ratings from from reputable sources like Consumer Reports, Motor Trend, Edmunds, and so forth. Owning an unpopular car is one thing. Owning a lemon is quite another. You don't want to be stuck with a loan on a lemon.
"Certified Pre-Owned" cars can also be very good deals, especially if purchased from a new car dealership that sells that brand of car. Most of these vehicles come with either the balance of the original vehicle warranty or an after-market warranty that may be even better than the original one.
If the car has an aftermarket warranty, be sure to ask exactly what the warranty covers and to get it in writing. Aftermarket warranties usually cover only the engine and power train, and some of the companies that issue the warranties are notoriously hard to deal with when claims arise. An extended warranty from the manufacturer is a better deal. Try to get one that will last at least as long as the loan you're taking out to buy the car.
Save Up for a Down Payment
Remember that the value of a new car drops as much as 20 percent the moment you sign the purchase agreement. That bothers lenders because the car will be worth less than you owe on it if they finance the full amount of the purchase. If you can cover that shortfall by walking into the dealership with 20 percent of the purchase price of the new car in cash in your pocket, your chances of getting a good loan deal are much better. If you walk in with more than 20 percent of the purchase price as a down payment, you'll almost certainly be driving home in the car of your choice.
By the way, "gap insurance" is usually a good thing to have. It's very cheap, and it covers you in the event that you total the car while its book value is lower than the amount outstanding on the loan. Insurance companies reimburse based on book value, so without gap insurance, you'll be liable for any debt owed in excess of what the insurance company pays the lender. Some gap policies also cover the deductible amount, and the coverage usually costs only a few dollars a month. For most people, I think it's worth it.
Research the Best Rebates
At any given time, auto manufacturers have multiple rebates in effect for various model cars, especially the ones that aren't selling too well. But not all of these rebates are advertised, and some are valid for only very short times. So when you're ready to start looking at new cars, call local car dealers and ask what the best current rebates are. You'll be surprised how many unadvertised deals are out there. For example, one of the rebates I got on my most recent car purchase was a promotion for veterans. I gladly accepted it and thought it was a very nice way to thank me for my service.
Your best chance of finding rebates high enough to cover all or most of the down payment is to go car shopping during the end of the model year (September through November), when manufacturers and dealers really need to move the ending model year's cars off the lot to make room for the new model year's cars. It's the absolute best time to shop for a new car.
In general, rebates should be applied as part of the down payment in addition to whatever cash you saved up. The higher the down payment, the less risky you look to the lender, and the better your chances of getting a good loan at decent rates. A higher down payment will also reduce your monthly payments. So don't be shy. Ask the dealership to look up every rebate and promotion they can find. It's in their interest, too. They make their livings selling cars.
Clean Up any Repossessions
Banks and other automobile lenders are much more concerned about repossessions than they are about bankruptcy. Most people who file for bankruptcy always managed to make their car payments on time, either because they needed the cars or because they loved them, and lenders know this. They know that no matter how poor most Americans get, we'll almost always find a way to make our car payments -- even if it means not eating for a while. We do love our cars.
What that means is that if you have a car repossessed, the lender concludes that either you're really, really poor, or that you don't particularly value owning a car. Either conclusion is a very bad thing when applying for a car loan. Having repos on your record practically guarantees that you'll be doomed to dealing with the Shylocks of the auto-financing industry.
Fortunately, repossessions are among the easier bad entries to get removed from your credit reports. This is because the process of repossessing a car requires so many "paper" ownership changes that whoever originally ordered the repossession may no longer have any record that the car ever existed, much less its having been repossessed. And just as with any other derogatory credit entry, a repossession than can't be verified must be deleted from your credit report.
Long story short, in most cases, if you formally challenge a repossession entry, it will be expunged. Either the company that ordered the repo won't have the paperwork, or they won't bother to reply to the verification requests from the credit reporting agency. Either way, unless it can be verified, the repo will disappear from your credit reports. Wait until that happens on all three CRA's records before shopping for a car. A repo on your record is the kiss of death as far as getting a good car loan goes.
Keep your Driving Record Clean
Most lenders (and all lease providers) will pull a copy of your driving record as part of the decision-making process. Why? Because they don't want to lend money or lease a car to someone who's likely to get it all banged up. Once a car gets banged up, people tend to get lax about their payments. So if a lender is on the fence about your application, a good driving record may tip the balance in your favor. Remember, the car is security for the loan.
If you're trying to lease a car (which is more much difficult to do than buying one is as far as credit is concerned), then a bad driving record will kill the deal. Leases are based on the assumption that when you return the car, it will be in good enough condition that the dealer can re-sell it at a good price with little more than a wash and a wax. A bad driving record makes that a lot less likely, making the already-difficult process of getting approved for a lease with a BK on your record even harder.
Learn How to Drive Stick
Manual-transmission cars are usually less expensive than their automatic-transmission siblings. They're also harder to sell because driving stick is rapidly becoming a lost art. When I learned how to drive, practically everyone knew how to operate a manual transmission. Nowadays, very few people do. Because of that, manual-transmission cars are not only cheaper than automatics, but they're also harder to sell. Many times the very best deals on the lot are manual-transmission cars, especially in the fall when dealers have to move cars to make room for the next year's models.
That's how I wound up with a new car this time around, by the way. It was autumn and the dealer had two manual-transmission cars in a model that they knew I liked, so my favorite sales lady called me up and offered me a test drive. I wasn't really looking for a new car, but I had some errands to run near the dealership anyway, so I took her up on her offer.
The deal was so good that by the time all was said and done, I couldn't afford not to buy the car. My monthly payments would be almost the same, and my insurance actually went down a bit. And one of the biggest reasons was because I knew how to drive stick and the dealership was desperate to get the stick-shift cars off the lot.
One thing you do need to consider is that used stick-shift cars are even harder to sell than new stick-shift cars, so both the resale and trade-in values will be lower. Another thing you need to know is that improper operation of a manual transmission, especially riding the clutch or holding the clutch down at traffic lights rather than putting the transmission in neutral, will burn out the clutch and/or the throw-out bearing in no time flat -- and it won't be covered under the warranty. So if you want to learn to drive stick, learn from someone like me who's good at it.
Where to Get a Loan to Buy A Car with Bad Credit
Buying a car after bankruptcy is one area in which it's often better to seek financing through the dealership, assuming that the dealership is a reputable one. Remember that both the dealer and the buyer have the same goal in mind: for the buyer to drive off in a new car. You want to buy one, and the salesman wants to sell you one. It makes life easy.
Car dealers usually have multiple lenders they do business with, typically running the gamut from top-notch to truly horrible. You may not be able to get a loan from the best lenders, and you don't want a loan from the worst lender. But if you follow the advice on this page, you'll have a better chance of getting a decent deal from one of the lenders in the middle.
Don't completely discount other lending sources, however. Credit unions, in particular, are often willing to make loans to bankrupt members who are on the right track to rebuilding their credit. Small community banks can sometimes be pretty easy to work with, too. But in all likelihood, your best chance of getting a car loan is through a dealership. Ford Motor Credit has an especially good reputation for being sympathetic to bankrupt purchasers. So do Kia and Hyundai, especially if you have some cash to put down. Unless you have a repossession on your record, a cash down payment of 10 percent will greatly improve your chances of driving a new car off the lot at a Ford, Hyundai, or Kia dealership. A 20 percent cash down payment is even better.
Capital One is also pretty accommodating. They offered me a blank check car loan a year or two after my discharge. That's where they literally mail you a blank check that can be used at any of many dealerships to buy a car up to the pre-approved amount of the loan. They wanted 16 percent interest, as I recall, which really wasn't that horrible for someone fresh out of bankruptcy. But I decided to wait and keep driving my old beater until I could get a better deal.
Which brings me to my next point: When considering financing offers from lenders, be realistic. You're bankrupt. Don't expect zero down and zero percent financing six months after your discharge. Maybe on your next purchase you can get that kind of deal, but not on this one. I'm not saying to allow yourself to be ripped off, but don't expect the same terms that people with great credit get.
If a dealer or other lender can get you an interest rate in the single digits with a recent bankruptcy on your record, that's pretty darn good. If they can get you 6 percent, that's fantastic. Kiss that dealer on the cheek. And if they can get you less than 6 percent, then you should kiss them on the lips and name your next child after them.
Realistically, however, expect to be offered interest rates of well over 10 percent the first few years after filing for bankruptcy, and even more than that if you've ever had a repossession. If you manage your credit well, the offers will get better; so waiting may be your best option.
Another thing to be aware of is that dealerships tend to "shotgun" credit applications, which means submitting them to perhaps a dozen or more lenders at once. Those are all "hard pulls" on your credit report. But CRAs tend to view all auto loan pulls made on an applicant within the same week or two as one pull because they consider it comparison shopping. So when you decide to visit multiple dealerships, visit them all within a two- or three-day window so all those credit pulls will count as one.
Finally, when the dealer reaches out to shake your hand and tells you, "You've been approved," you may be so happy that you temporarily take leave of your common sense. So take a moment before signing on the multiple dotted lines to ask some questions, the most important of which is, "On what terms?" Then review the loan offer, read the contract thoroughly, ask if it's the very best the dealer can do, and make your decision accordingly.