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It depends. In truth, there are quite a few circumstances where buying a car before Chapter 7 or Chapter 13 bankruptcy might make sense.
Buying a car after you file bankruptcy is going to be a challenge. But keeping a car loan out of bankruptcy by reaffirming it can also present issues depending on the car’s value, how much you owe on the car loan and your ability to make the payments.
Overall, this is a discussion to have with a bankruptcy attorney who can walk you through your situation and state regulations.
Factors to consider when purchasing a car before bankruptcy
You can buy a car before bankruptcy, but it’s not always the best course of action. Depending on your access to other forms of transportation, the value of the vehicle and your ability to secure a loan, you may want to go without until you’re in a better financial position.
How much the vehicle is needed and alternatives
If your current car is on its last legs and you don’t have access to reliable transportation, buying a car is a necessity. You and your attorney can determine how best to determine need in your situation, but bankruptcy laws allow for you to keep your car — even a newly purchased one — in these circumstances.
However, living somewhere with reliable and affordable — compared to a car payment, maintenance and insurance costs — public transportation may mean you aren’t able to keep your car out of bankruptcy filings.
And even if you need the car, consider your access to other alternatives. Public transportation, ride sharing and friends may be able to cover your needs. In this case, it could be worth holding off on a big purchase even if it won’t disrupt the bankruptcy process.
Whether the vehicle will be protected
The bankruptcy trustee or your lender will likely require you to reaffirm your debt, meaning you will continue to make payments on it like you did before filing for bankruptcy.
That being said, your car will be protected from repossession if its equity doesn’t exceed federal or state exemptions. The federal exemption for car equity is $4,000, but your state may allow more or less.
The equity is determined by the car’s value compared to the amount you owe. So when you’re looking for vehicles before bankruptcy, ensure that they don’t exceed the exemption amount. If the car you buy does, you may be forced to sell it to pay off other creditors.
Type of bankruptcy being filed
Whether you file for Chapter 7 or Chapter 13 will have an impact on your ability to purchase a vehicle. Since Chapter 7 removes most or all of your unsecured debts, a car loan may not influence your ability to qualify — provided it qualifies as an unsecured loan.
To do this, you will need to certify it and ensure your title has a lien against it by the lender. This is the most common way car loans are handled, so it likely won’t mean extra work on your end. You will also need to ensure your car qualifies as exempt and is valued under the exemption amount set by your state. Otherwise, you’ll have to pay the difference or risk losing the car.
Chapter 13 creates a payment plan for your current debts, which includes any nonexempt equity your vehicle has. If you aren’t able to repay this, you’ll need to sell the car yourself or turn it back over to the lender.
How to buy a car during or after bankruptcy
At a high level, the exact steps will depend on when you choose to buy your car and if you need to finance it. Buying a car during or after bankruptcy isn’t unheard of, but you’ll want to stay on top of things to keep on the right side of the law.
Buying a car during bankruptcy
The biggest issue with buying a car during bankruptcy is the money used as a down payment. Nonexempt cash that should go to your creditors can’t be used to fund your vehicle. When you file your bankruptcy paperwork, the court may see a large down payment as an attempt to evade paying your creditors. Fortunately, it’s unlikely to cause problems if you make a small down payment to buy an inexpensive vehicle that you can prove is a necessity.
In addition, your lender may request that you sign a reaffirmation agreement to remove your new loan from your bankruptcy filing. The most difficult part will be finding a lender that will work with you. It’s not impossible, but it can be hard.
If you plan to purchase your car outright without financing, you may face the same issue as if you made a large down payment. It’s important to keep your lender filled in on the process so they can guide you toward a legal purchase during bankruptcy.
Buying a car after bankruptcy
It’s not impossible to buy a car after bankruptcy, but it will be expensive. Lenders see bankruptcy as a significant risk. Your interest rate will reflect this risk, and you may end up with rates upward of 20%. You may also be approved for less, limiting the type of car you can afford to buy.
But it’s not all bad. There are some dealerships and lenders that work with people who have declared bankruptcy. If you are approved for a loan, on-time payments can help you rebuild your credit score. This will make it easier to afford a less expensive loan in the future or refinance your auto loan later on.
The bottom line
If you need a car — and can prove that need — then buying a car before bankruptcy may be a smart move. It’s easier to find financing without bankruptcy on your record. However, discuss a big purchase like this with your bankruptcy attorney first. Your attorney will understand your unique situation and be able to guide you through the specific laws and regulations in your state.