debt

Debt settlement tough on car buying

Steve Bucciq_v2.gifDear Debt Adviser,
If I enter into a debt settlement program, will I be able to obtain a loan to buy a car?
-- Cheryl

a_v2.gifDear Cheryl,
Let's turn this question around and see if that helps. If I borrowed $1,000 from you and paid you back only $500, would you be willing to loan me $5,000? My guess is no. But the world of credit can be a funny place, so the real world answer to your question is a resounding, "It depends."

Generally speaking, lenders do not like to see accounts on your credit report that have been "settled." You are more likely to get favorable terms on a new loan when you make good on all your past credit obligations. Paying late will lower your credit score, but as long as you eventually made good on what you owed, the lender may view the account more favorably than an account that was settled for less than was owed.

I can't tell from your question whether you are considering a debt settlement program offered by your lender or one offered by a debt settlement company. If the former is bad for your credit, the latter can be much worse. Companies that perform these services typically charge a large upfront fee and have very poor results. I don't recommend them. You can easily find yourself on the receiving end of heavy fees, high interest rates, collection calls and court actions while you are making payments to the company. The company is accumulating your payments until they have enough money to "settle" your account(s), and very few accounts actually settle. If the company that you owe is offering a settlement, then be sure to get all the terms in writing before you send in any money and be aware that the IRS may count a forgiven debt as income to you if it is more than $600. I mean taxable income, that is! So be sure to save enough money to pay the tax bill in April.

Should you move forward with your plan to enter into a debt settlement program, be prepared to pay more for your car loan if you qualify. According to Bankrate.com, the national average for a 36-month auto loan for the top FICO credit score range of 720 to 850 is an interest rate of 6.36 percent. At the bottom of the FICO credit score range of 500 to 589, expect a rate of 18.414 percent interest for the same 36-month loan. Ouch!

In today's very tight credit market, many lenders will just not make higher risk loans at any price, so expect to have to shop around for the best deal. Try to do all of your rate shopping in a limited time period. The credit scoring elves that FICO uses know that looking for an auto loan may cause multiple lenders to request your credit report, even though you are only looking for one loan. To compensate for this, your score ignores auto loan inquiries made in the 30 days prior to scoring. So, if you find a loan within 30 days, the inquiries won't affect your score while you're rate shopping.

In your case, I'm afraid your shopping may take some time. So if you go beyond the 30-day period, the score treats all your auto loan inquiries older than 30 days as a single inquiry for each subsequent 14-day period. Expect that any lender you approach will want a much higher down payment and a much higher interest rate to lend you the money. Also, expect that if you miss a payment, they will repossess the car very quickly.

Groucho Marx said that he didn't want to belong to any club that would take him as a member. My concern is that any lender who would lend you the money is not one you want a loan from.

Be careful and good luck!

To ask a question of the Debt Adviser go to the "Ask the Experts" page. Read more Debt Adviser columns and more stories about debt management.

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