A client recently called me to express his frustration at how many car dealerships were soliciting him to buy a car while he was in Bankruptcy proceedings. He thought nobody would lend to him after the Bankruptcy, and in truth, the opposite is actually true.
Why is that?
Well, first of all, if you filed a Chapter 7 Bankruptcy, you cannot file another one for 8 years which makes you a great person to lend to for the next 8 years. Second of all, you got rid of all that debt weighing you down, so you have money in your monthly budget to service that new car loan. Third, they will take advantage of the fact that you recently filed for Bankruptcy, and charge a very high interest rate.
Keeping all of these things in mind, should you buy a car after Bankruptcy? The answer is “yes”, but you have to understand the process and be a careful consumer.
First, keep in mind that loans for people who recently filed for Bankruptcy will have very high interest, and the salesman associated with those loans get very high commissions. So, their incentive is to put you into the most expensive car possible. Now they also know that high interest on a high balance loan means a high monthly payment, so in order to entice you into the loan, they will play a shell game with the numbers. What they will do is stretch out the loan for a longer period of time. This will lower your monthly payment while still allowing them to recover their high balance and high interest.
Don't fall for this. A typical car loan is between 3 to 5 years. Don't let them put you into a 7 or 8 year car loan at high interest.
Also, since their commission is based upon the balance of the amount financed, they have an incentive to finance a larger loan. They will act like they are doing you a favor by showing you nice (more expensive) cars, but this is also a game of distraction. Most people are so happy that somebody will lend to them after a Bankruptcy, and when the car salesman is showing them really nice cars, it almost seems too good to be true…and yes, it is too good to be true.
In order to make that loan work they will amortize that loan over so many years that in a very short period of time, your balance on that loan will remain high (because your payments are low), but the value of the car will be significantly underwater.
So, should you even try to buy a car after Bankruptcy? Absolutely, but you have to be realistic about what you are working with. If the interest rate is going to be high, then you need to lower the amount you are going to finance. For most people, I recommend only financing between $7,000 to $9,000 for your first car after Bankruptcy. Pick a car model that is known utterly reliable. Insist on a car loan that is 60 months, or less. If possible, occasionally make extra payments on the car loan to pay off the note faster. If you do that, the high interest will not be punishing, and eventually you will have equity in the car that you can use as a down payment on your next car. At that point (perhaps 2 – 3 years after your Bankruptcy), you can afford to put this car as a down payment on a newer car, that is a little bit more expensive, as long as the interest rate is lower, and the loan term remains 60 months or less. Typically, I prefer that my client's monthly payment on a car loan is 10% (or less) of their monthly take home pay. This should give you an idea if you are being steered in the wrong direction.
For example, if your monthly take home pay is $3,000 per month, then your monthly car payment should be no more than $300 per month and the loan term needs to be 60 months or less. If the car loan exceeds these parameters, you are being taken for a ride (excuse the pun).
So, the bottom line is that buying a car after Bankruptcy is absolutely a possibility, but you must be a careful consumer. Remember, they want your business, so you don't have to take a deal that is bad for you just because you need a car.
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