How to get a Car Loan after Filing for Bankruptcy

Bankruptcy is on the rise, despite reforms that were intended to reduce the number of consumer filings for bankruptcy.  Yet despite the growing ranks of recovering bankrupts, a reliable car remains one of the keys to independence and often is the difference between working and unemployment.  Lenders will be wary of a loaning money to any person who has recently filed for bankruptcy, and the more recent the filing the less attractive the borrower is to the bank.  Nevertheless, it is possible to get a car loan after filing for bankruptcy with some careful planning and understanding how the loan process will work.

Car loans are almost always secured loans.  That means that the lender keeps a legal interest, called a security interest, in the ownership of the car until the loan is paid off.  This allows the lender to repossess the car if the borrower stops paying.  This will make the lender a little bit less concerned about loaning the money to a former bankrupt debtor: unlike credit cards, the bank has a priority debt in the car and a way to make that debt good by taking it and auctioning it.

Car loans, especially on new cars or expensive used cars, are also different from many other loans because they are frequently upside-down for much of their first year or two.  The car loses value faster than the debt is paid down, which makes the process of repossession and auction less attractive to the lender.

This leaves a borrower with two main choices for getting a car loan in the wake of a bankruptcy.  The borrower can either pay a heavy premium in the form of higher interest rates or can arrive with enough cash for a down payment to reassure the bank that it will not hold legal title to a car worth less than it is owed on the loan.  The first choice is not the best, and might be the first step back toward another bankruptcy.  Lenders generally adjust their rates based on the risk of default and the likely consequences if there is a default.  A borrower who just emerged from bankruptcy is a bad risk of default for the bank, and holding an upside-down car loan makes the consequences bad for the bank.  They will make up for it by charging a much higher interest rate, and the borrower will pay more over the life of the loan.

This leaves the second option: arrive at the negotiating table with enough cash to make a good down payment so that the lender knows that the risk of default (still relatively high) is countered by the fact that at least they will be able to auction the car for more than the loan amount if you do default.

Before taking either step, think hard about whether you really need a car and a car loan so close to your bankruptcy.  Waiting to buy a car serves two important functions.  First, the effect of the bankruptcy on your credit score will diminish over time.  If you wait a year or two between the bankruptcy and asking for a new loan, you will have demonstrated that you have fixed the problems that caused the bankruptcy and might get a better rate.  In addition, waiting to buy a car gives you time to save more money for the down payment, which will make your payments lower and will give the lender a reason to offer a lower rate because they will not be holding an upside-down loan.

It is possible to get a car loan after bankruptcy, but be very careful about reading the terms of the loan before agreeing to it.  High interest rates, large payments, and aggressive late fees might put you back where you were before bankruptcy.