Buying a car can feel stressful enough, but when you have been through bankruptcy it may feel downright terrifying. No matter what the circumstances that led to your filing -- large medical bills or a job loss, for example -- you probably feel embarrassed and afraid that no one's going to want to give you the time of day, much less a decent loan.
"The most important thing to know is that you do have options," says Phil Reed, senior consumer advice editor for the car buying platform Edmunds.com. He says lenders are interested in working with borrowers who are recovering from financial problems, and in fact some dealerships are eager to sell them a car. "You shouldn't assume that no one will talk with you and that you have to take whatever someone will give you," he says.
Here's how to get a car loan after bankruptcy, step-by-step. (By the way, this advice also applies to someone in the process of a Chapter 13 bankruptcy which usually takes five years to complete. The difference there is that you need to talk with your attorney because you will likely need permission to take on new debt while in a repayment plan.)
1. Get your credit reports and credit scores
Yeah, checking your credit probably feels a little like pulling a bandage off a big gaping wound. It's not going to be pretty. But the lender is going to check your credit, so you might as well know what they are going to see. Besides, it's always a good idea to review your reports after bankruptcy because mistakes are not uncommon.
You can get your free annual credit reports from AnnualCreditReport.com and you can get a free credit report summary from Credit.com that explains how lenders are likely to view your information. Although the lender will pull a customized credit score that likely differs from the one you see, it will still give you an idea of where you stand in general.
Pay particular attention to what the report says about previous auto loans, since those are often more heavily weighted in the credit scoring models used by auto lenders. Positive on-time car loan payments reported during and after bankruptcy can be helpful.
Connecticut bankruptcy attorney Eugene Melchionne suggests asking yourself the following questions: "Was there a previous car loan involved in the bankruptcy? Was that car loan reaffirmed?" (When you reaffirm the loan you agree to continue to pay the loan balance rather than wiping it out.) "If the loan is reaffirmed, then the tradeline (account) should be showing up on the credit report."
If you did not reaffirm a loan on a car you held onto in bankruptcy, then the account probably won't be on your credit reports, even if you have continued to make payments. "In that case, I have the borrower go the dealer/lender prepared with proof of post-bankruptcy payments to create the history," Melchionne says.
2. Put together a down payment
Hopefully wiping out debt in bankruptcy improved your cash flow enough that you can save some money for a down payment. "I tell my clients to plan on living an entire year on a cash-only basis and build up savings before getting back into the credit game," says Melchionne. The larger your down payment, the less risk your lender is taking. After all, they also have your vehicle as collateral. Need a set of wheels right away but short on cash? A trade-in can help toward a down payment, and you may be able to get more cash for your current vehicle if you sell it yourself.
3. Shop around
Gather all your financial information (pay stubs, copy of your credit report, etc.) and dedicate a day to getting preapproved for a car loan. It's a good idea to limit your shopping to a single day to minimize the potential impact multiple inquiries may have on your credit scores.
Ideally, try to get preapproved before you visit the dealership. "Like any car buying expedition, you have the best leverage if you get approved for a loan before you shop," Northern California bankruptcy attorney Cathy Moran says.
If your bankruptcy is recent and you haven't been able to start to rebuild your credit, you will probably wind up with a higher-rate loan. According to Experian Automotive data, the average auto loan rate for someone with deep subprime credit (VantageScore credit score of 300 to 500) was 13.29 percent for a new vehicle and 18.95 percent for a used one. (All figures as of fourth quarter 2014.) And the average new vehicle payment for someone in that credit score range was $497, while the used vehicle payment averaged $373.
"If you have an offer in hand you can always then try the dealership," Reed says. "Quite often they will offer to match it or beat it."
4. Avoid the worst loans
Don't assume a "buy here, pay here" dealer is the only one who will work with you. Instead, make that your absolute last resort. "The interest rate will probably be sky high and often it is quoted per month, not per year," Reed cautions. Plus, "you don't get a great selection of cars and they may be unreliable" he says, which means you could be stuck with a car payment and large repair bills at the same time.
Also be very cautious about any auto financing contract before you sign on the dotted line. Subprime borrowers can easily end up in predatory loans. It's important to make sure there aren't hidden costs in the contract (for undercoating or other services you don't need, for example) and that you can comfortably afford the payments. If you default on this loan, bankruptcy may not be an option because of your recent filing, so you want to be extra careful.
5. Pay on time
Your vehicle loan can help you improve your credit after bankruptcy, provided you make your payments on time. How much can it help?
Equifax compared consumers with deep subprime credit scores (below 550) over a three-year period and found that those who took out an auto loan during that time period had larger increases in their credit scores compared to those who did not. Specifically, the median improvement in scores for those who did take out a vehicle loan was 52 points. The report titled Subprime Auto Loans: A Second Chance at Economic Opportunity states, "This is a 62.5% improvement over the group that did not take out an auto loan, who only improved by 32 points. Even more telling, those that took out an auto loan were four times more likely to have improved their score above 640 compared to the consumers who did not take out a loan."
Monitor your credit scores after your bankruptcy. Hopefully you will find that once you've paid your loan on time for six to 12 months and have been building better credit, your scores have improved. If so, you may be in a position to refinance your car loan at a lower interest rate. (Of course that's never guaranteed, so don't take out an expensive car loan thinking you'll just refinance later.)
And one more tip: If you are reading this because you are contemplating filing for bankruptcy but drive an unreliable car, you may want to replace it sooner rather than later. "I end up sending a fair number of clients out to buy a car before they file bankruptcy," says Moran. "My thinking is that many are more creditworthy, at least in the car-buying context, than they give themselves credit for, and they often qualify for manufacturer-underwritten loan terms." But those clients don't get a "free" car. "The deal is, they pay that eve-of-bankruptcy loan in full according to the terms of the deal, despite the bankruptcy filing," she says.