What if I’ve been bankrupt?
Or, how a car loan may help you rebuild your credit
Bankruptcy presents a challenge to car loan approval, but it’s not an impassable barrier. Every situation is unique, from the cause of your bankruptcy to the extent of your debt. As we’ll explain, a car loan can be the perfect place to start rebuilding your credit, even if you’re emerging from personal bankruptcy. Here’s everything you need to know.
Bankruptcy in Canada
The Canadian bankruptcy process is governed by federal law through the Bankruptcy & Insolvency Act. While potentially losing some of your possessions or property is a painful process, the goal is to allow you to escape your debts and start again without your existing financial burden. After your debtors have been paid, the remaining debt you owe will be cancelled, with a few minor exceptions.
To file for bankruptcy in Canada, you must owe creditors at least $1,000 and be unable to repay your debts. (You must also live or work in Canada.) If you’re in this situation, the process starts with the hiring of a federally licensed bankruptcy trustee, who helps you file for bankruptcy. Trustees charge fees for their services, but regulation ensures fees are reasonable and that the bankruptcy process does not become another major financial burden to you.
The Role of the Trustee
With your help, the trustee catalogs all of your existing assets, as well as any assets you have discarded in recent years. You also are required to surrender all credit cards to the trustee. However, you are no longer required to make payments to creditors, subject to wage garnishments, or liable for lawsuits filed against you by your creditors.
The trustee sells your remaining assets to generate as much cash as possible, which is held in a trust. From this trust, the trustee settles your debts with existing creditors, usually by agreeing to pay a percentage of what’s owed. Assets may include your car, house (if you own it outright), or other items of value. If your income exceeds a sliding threshold for a federally defined standard of reasonable living, you may be required to submit “surplus income” to your trustee for distribution to creditors.
Discharge and Debt Cancellation
The process of discharging your bankruptcy takes about nine months for your first bankruptcy. If you qualify as having surplus income, it could take up to twenty-one months as you continue to make payments to creditors. If you are filing for bankruptcy a second time, the discharge process can last for up to three years. Instead of an automatic discharge based on elapsed time, a hearing may be called to confirm or deny your discharge, depending on the situation.
During the bankruptcy period, you must complete certain responsibilities to finalize the process, such as attending two financial counseling sessions and assisting the trustee with the distribution of assets. It is critical that you are fully honest with your trustee and other parties at all times during your bankruptcy proceedings.
After discharge, your debts are cancelled, with some exceptions. You will still owe payments for alimony, child support, student loans, court fees, and debt accrued from fraudulent practices.
Bankruptcy and Your Credit Report
Immediately after emerging from bankruptcy, you have the lowest possible credit rating. A note on your credit report about your bankruptcy remains on file for six or seven years following your first bankruptcy. For subsequent bankruptcies, it may remain for up to fourteen years.
This is a primary hurdle when it comes to securing credit for a car loan or other major purchase, but it doesn’t tell the entire story. In many cases, a work-related injury or job loss may have caused the bankruptcy, not irresponsible spending habits. Factors specific to your bankruptcy come into play as you look to rebuild your credit and secure financing.
Getting a Car Loan after Bankruptcy
For lenders, the obvious concern is getting repaid. A bankruptcy in your recent history means lenders face above-average risk if they decide to loan you money. For anyone applying for a car loan, lenders may look as far as ten years into previous credit history, but the most important time period is the most recent two years. If you’ve already made it through this window post-bankruptcy, it’s a positive sign to a lender.
That said, you’ll still want to spend time evaluating all your options. While consumers with high credit scores enjoy low interest rates from most if not all lenders, people with a bankruptcy in their past may find it difficult to get a manageable rate—or even approved at all. Make sure you explore your options thoroughly before deciding on a lender.
Factors Lenders Consider
When automotive lenders begin investigating the credit of someone with a past bankruptcy, the single most important factor for approval is a successfully repaid car loan. To the lender, it demonstrates commitment and establishes a positive history. If you’re currently up-to-date on payments for an existing vehicle, all the better.
In some cases, this includes maintaining payments during the bankruptcy process. If your debts are not excessive, you may be able to continue making car payments—and keep your car—as you go through bankruptcy. This is a very positive signal to an auto lender. A repossession of a car is far more detrimental to your ability to secure a loan than a general bankruptcy.
Paying your mortgage is another major factor, although the financial crisis of the late 2000s shifted lenders’ emphasis away from mortgage status as a leading determinant. During the financial crisis, so many consumers were behind or “underwater” on their home payments (they owed more than their home was worth), that focusing on mortgage status eliminated many legitimate loan seekers.
Often, local lenders provide a better option because they understand local economic situations, like a rash of job layoffs. Additionally, you may find that dealerships are more willing to extend credit as it’s mutually beneficial. You get to drive away in a car you need while rebuilding your credit, and the dealership gets to move a car off its lot.
Part of what makes car loans an effective way to build or rebuild credit is that the car you purchase serves as collateral for the loan. You’re not required to have a separate asset to secure the car loan. Still, smart lenders should help you find a car that matches your current income level. In general, the more of a financial stretch the monthly payment may be, the more money you should expect to put down in advance. More money down protects the lender in the event of a default or repossession.
Cautions and Alternatives
And while it may be difficult to find a willing lender, be cautious of any lender offering guaranteed loans regardless of your credit, or a lender demanding upfront fees or wire transfers before processing your loan. These are tell-tale signs of irresponsible or potentially fraudulent lending practices.
If you’re unable to get approval for a car loan, the fastest and easiest way to build your credit is with a secured credit card. Unlike regular credit cards, secured credit cards require a security deposit equal to the credit limit. You then use a secured credit card like a regular credit card and pay off the balance each month. The lender is protected by your security deposit, which covers any balance you’re unable to repay.
Like monthly payments for traditional credit cards, payments on the balance of your secured credit card are reported to credit bureaus to help rebuild your credit. The setup isn’t appealing for those with good credit, but it’s a useful interim measure to demonstrate your ability to manage credit.
The Lender’s Perspective
Because the car serves as collateral for the loan, it represents less risk from the lender’s standpoint. However, it’s still not without risk. This is in part because some 20 percent of the value of your car disappears as soon as you drive it off the lot. So, if you buy a car for $20,000 and finance the entire purchase, that car is worth only $16,000 the moment you leave the dealership, even though you’ll still owe $20,000.
The dealer also takes on risk for potential damage to the car beyond normal wear and tear. That’s why, even if you’ve undergone bankruptcy, a clean driving history without recent or repeat accidents or traffic violations might help you secure a car loan. If your car is repossessed but has no damage, the car will be worth more, and the lender will be able to recover more. All other factors being equal, a good driving record can help tip the balance in your favor. The converse is also true.
Still, the process of repossession represents an expense to the lender. The lender needs to pay a repossession service to obtain and store the car, and cover auction fees for your vehicle. At auction, most cars sell below their “book value,” which also is likely to be less than the amount of the loan.
The Value of a Down Payment
If you’re able to provide a 20-percent down payment for your vehicle, it decreases the risk to the lender because after you drive off the lot, your loan amount will equal—not exceed—the value of your car. You’ll never be “underwater” on your car loan. In many cases, rebates offered on certain cars can be put toward a down payment, which bolsters the likelihood of approval and makes monthly payments more manageable.
If you’re able to provide an even greater down payment, say 30 to 40 percent, it provides added security for the lender and increases your chances of approval. As always, financing a smaller part of your purchase results in lower monthly payments, which may help you stay on track over the long term.
As we mentioned at the top, every situation is different. But bankruptcy still leaves open the possibility of obtaining an auto loan. In fact, an auto loan may be the perfect way to help you recover from a troubled financial past.
To find out where you stand, get in touch with a lender that’s committed to helping you make the right decision, whether that’s choosing an appropriate car or finding ways to build your credit to increase your eligibility. Take the first step today.