You are thinking about buying a car, but are not long out of bankruptcy. What can you do to increase your chances of qualifying for a loan without having to pay a sky-high interest rate?
Here are 10 suggestions:
1. Take some time to rebuild your credit and save for a down payment. You can probably find a lender who is willing to give you a loan immediately after bankruptcy, but you will be paying subprime interest rates. Borrowers with credit scores below 580 may pay two or three times the rates of borrowers with credit scores in the mid-600’s and five or more times the interest rates of borrowers with scores above 700. You will get a better interest rate and find more lenders who are willing to approve you for a loan if you give yourself a year to mend your credit. During this time, pay all your bills and debts that survived your bankruptcy on time. Get a credit card. You will probably have to settle for a low credit limit and high interest rate. You may even need to deposit some money with the bank to secure the card. Use the card sparingly and pay off the balance in full each month to avoid interest. Even six months of regular credit card payments can make a difference. Now that your debts have been discharged, you may have some breathing room in your budget for savings. Try to save some money every month toward a down payment. The bigger your down payment and the smaller your loan, the more willing lenders will be to lend to you as their risk goes down. Also, the easier it will be for you to make your monthly payments.
2. If you came through your bankruptcy with a car loan, make sure to keep up the payments. Auto lenders typically weigh your history with previous auto loans heavily in deciding whether to extend credit. Timely car loan payments made during and after bankruptcy can help you get a better interest rate. If you reaffirmed your car loan, your loan should show up on your credit report. If you did not reaffirm the loan, but kept the car and continued to make the payments, the loan probably won’t be on your credit report, but you can show the lender proof that you have been keeping up with the payments.
3. Check your credit before applying for a loan. You can get a free credit report every 12 months from each of the three major credit reporting agencies: Equifax, Experian, and TransUnion, from AnnualCreditReport.com. Get your reports, review them, and dispute any errors you find. Getting errors corrected may boost your credit score. Give yourself at least a month before you plan to buy to get your credit report cleaned up. Once you know your credit score, you can check online to get an idea of what interest rate (or range of rates) you can expect to be offered.
4. Consider adding a co-signer. Adding a co-signer with good credit to your loan can lower your interest rate and improve your chances of approval. However, you may have trouble finding a co-signer in view of your recent bankruptcy. If you find a family member or friend who is willing to co-sign, be sure you can pay your monthly payments. Bear in mind that if you default on the payments, your co-signer will be responsible to pay off the loan. If that happens, your relationship with the co-signer may be irreparably damaged.
5. Shop for a loan and get pre-approved. Now that your bankruptcy is over, you may already be receiving loan offers in the mail. Don’t just grab the first one that shows up. And don’t limit yourself to seeking financing from the dealer. Dealer financing may be convenient, but if the dealer isn’t competing for your business, the dealer has no incentive to offer the best deal. Shop around for the lowest interest rates. You can try banks, credit unions, and online auto loan lenders. You may find you get a better deal with a bank that you already have a relationship with, a smaller community bank, or credit union if you are or can become a member. Applying to a few lenders is a good idea because different lenders weigh factors in your credit report differently, so car loan offers can differ significantly. Try to get preapproved for a loan. Being pre-approved puts you in the same position as a cash buyer and gives you more negotiating leverage at the dealership. Don’t confuse pre-approval with prequalification. Pre-approval means a lender has done a full credit check on you to determine the amount of the loan and interest rate you are likely to get. Prequalification means the lender has reviewed the financial information you have provided and offered you a rate or range of rates that may change after a full credit check. Prequalification may be useful if you are “testing the waters” and not quite ready to buy, but preapproval is what you want if you are prepared to make a deal. A pre-approval application is a “hard” credit inquiry that reduces your credit score. When applying for pre-approval, do all your loan shopping within two weeks to minimize damage to your credit score because multiple hard credit inquiries within a short time count as just one. If your income is low, investigate whether your state has any nonprofit agencies that provide loans or vehicles to low-income consumers.
6. Figure out how much you can afford to pay. Once you are preapproved, you know your interest rate and the most you can borrow. But the most you can borrow is not necessarily what you want to pay for a car. You first need to make sure you can afford the monthly payments. You can use an online auto loan calculator to figure out your payments. The calculator will prompt you for the price of the car, anticipated down payment and trade in value of an existing vehicle, interest rate, and loan term. You’ll need to deduct about 10 percent from the price of the car to cover taxes and fees. The auto loan calculator can also tell you the total amount that you will repay over the term of the loan. Check your budget to make sure you can comfortably afford the payment. Be realistic. Don’t forget to consider other car related expenses like registration, insurance, gas, and maintenance. If the payment is too high, you can borrow less and get a less expensive car. You know your budget better than the lender. Don’t let the lender get you into trouble. If you take on more debt than you can handle, another bankruptcy will not be an option for a while, so you want to be very careful. Once you know your budget, you can begin researching what types of vehicles are available in your price range. Check Consumer Reports or a similar publication to identify reliable models. If a new car is too expensive, consider a late model used car with relatively low mileage that you can drive for at least 5 or 6 years. If you choose a used vehicle, check the vehicle history and have it looked at by a mechanic before you buy. Be wary of buying a cheap high mileage car that will cost you a lot in repairs and need to be replaced before you are even finished paying for it.
7. Work with a reputable dealership. You can check with your state’s attorney general and the better business bureau for complaints. Also ask family, friends, and neighbors for recommendations. If you plan to buy your car in a private sale, rather than through a dealer, verify that your lender will allow it. Some won’t.
8. Compare dealer financing. Once you have been preapproved for a loan, you can see if the dealer can offer you a better rate. Dealers may be able to offer better rates through “captive lenders” set up by the car companies just to make auto loans.
9. Avoid “buy here, pay here” dealers. “Buy here, pay here” dealers offer financing with low qualification requirements. They market aggressively to people with poor credit. The interest rates offered are usually close to the maximum permitted by law and the vehicles are often older with high mileage and may require costly repairs. To induce you to buy, the dealer may offer a very long term loan that reduces your monthly payments, but an extended payment plan increases the interest you pay even more. These dealers will offer financing to just about anyone, but they should be considered only as a last resort. Public transportation, if available, may be a better option while you work to improve your credit.
10. Refinance after a year of on-time payments. After a year of making payments on time, you may be able to refinance your car loan to get a lower interest rate that can save you hundreds of dollars. When you get preapproved for a loan, ask the lender if refinancing after a year is an option and what steps you will need to take to qualify.