Auto Financing After Bankruptcy – Marlon Answered

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How much should Marlon spend for a vehicle?

DFA reader Marlon asked:

“On super bowl Sunday of last year my sister in law totaled my car. 15 days later we bought a 99 Mercury Cougar.  We went to a buy here pay here car lot.  As of March 1st we will have made one year of payments. Just this past December I got my bankruptcy discharged. I would like to get out of the 99 Cougar and into something safer.

How long and how much should I come up with for a used vehicle?”

The 1/10th Rule for purchasing a vehicle

I first saw this concept used by the Financial Samurai, and I like it.  The 1/10th Rule states that the car you buy should cost no more than 1/10th your gross annual salary.  Example:  If you earn a $50,000 yearly salary [50,000/10 = 5,000] you should spend no more than $5,000 toward your next vehicle.

Marlon, divide your annual salary by 10.  That is the limit on how much you should spend toward a vehicle.

Financing after bankruptcy

You also mention the fact that you just had your bankruptcy discharged in December, 2009 and are wondering how long you should wait.  I am assuming you mean how long you have to wait before you can be considered for additional financing for yet another vehicle.  I have a couple of things to say about that.

  1. Can you finance? Financing purchases may be what caused your bankruptcy in the first place.  You said you were making payments on the 99 Cougar and that March 1st will mark 1 year worth of payments, but you also stated your debts were discharged in December.  Did that discharge not include the auto loan for Cougar?  Do you still owe on the Cougar?  If so then the last thing you should be thinking about is financing another vehicle.  If the Cougar is unsafe AND unpaid then you need to focus on getting that debt settled ASAP… THEN you can begin saving money toward another used vehicle.
  2. How long until you can finance? Although a bankruptcy can remain on your record for up to 10 years, its effect on your credit can begin to lessen the day after the case closes.  As long as you handle your finances responsibly from here forward, your credit will improve sooner than you might expect.  How soon you will be available for financing depends on how responsibly you handle your credit from here on out.
  3. Rebuild your credit. Your credit has taken a hit and needs to be nursed back to life.  If your debt to income ratio (the measure of your monthly debt payments to your monthly gross income) is raised too high too fast your credit will never improve and you’ll find yourself back in financial trouble but without another bankruptcy net to fall into.  If you must borrow, do so a little at a time.

Here’s what I would do Marlon:

I would not finance another vehicle.  You mention the Cougar is not safe.  If the Cougar is not beyond repair then do whatever necessary to get it operating safely.  Will new brakes make it safe?  Then get new brakes.

If it is beyond repair then do the following:

  1. Find alternate transportation (friends, bicycle, bus, etc.)
  2. Cut out all unnecessary spending.
  3. Save extra money toward your next used vehicle.

Do this as long as your situation will allow, or until you have enough money saved to buy a vehicle in sound operating condition.  You can find such vehicles for as little as $1,000 if you know how to look.  Also, remember not to spend any more than 1/10th your yearly salary on the vehicle.  So if 1/10th your salary is $5,000 – then shoot for somewhere between $1,000 and $5,000 for the vehicle.

What do you think?

What would you do if you were in Marlon’s shoes?

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1 Trey

1/10th your income? I am sorry but that is beyond ridiculous, if everyone abides by that no one would be able to afford a new car. Even the lowest priced cars are retailing for $20,000 these days, so you are saying the average family would need to bring home over $200,000 just to drive a used ford sedan? I just don’t see how someone could recommend spending less than 10% of your income on a car presently given the significant improvements in safety, fuel consumption and emissions that have come about in the last 10 years. I am all for saving money, but there comes a point when excessive frugality can really hurt more than help.

As someone who sees the difference between $5,000 cars and $20,000+ cars after accidents on a daily basis, if I had a family I wouldn’t be going for the clunker…

Edited to add: The author of that post is grossing over 100k a year, no wonder he feels comfortable with such a guideline. For those of us mortals making less than $50,000 that is just unrealistic.

2 Financial Samurai

Trey – That’s exactly what I’m saying. If you’re not making $200,000/year, I think it’s financially destructive to spend much more than $20,000 on a car. There are PLENTY of cars that cost under $20,000 new, and TONS of cars that cost under $20,000 used.

The 1/10th rule is a guideline, not the a law. People go crazy over cars and try and justify their car purchases every which way, at the expense of their finances.

Best, Sam

3 Credit Card Chaser

I agree that the 1/10th rule is a great place to start. @Trey I do think that there is probably a certain baseline number where any income below that number maybe doesn’t apply though. For example, if you only make $20,000 per year and you need a reliable car to get a good paying job and start to make more money then by all means if you have to then spend more than $2,000 on a car!

4 Financial Samurai

Honestly, if you are close to the poverty line at $20,000, you should probably be taking the bus and not driving at all! Bike, bus is the only way to go. Then focus like heck to improve your income.

5 Matt Jabs

There are always exceptions, but the 1/10th Rule is a great place to start for those looking to live below their means.

Also, a car does not need to cost $20,000 to be safe. My 2000 Jeep Cherokee and my wife’s 2002 Pontiac Grand Prix are both VERY safe, and are both worth less than $5,000.

6 Treesje

Maybe the more relevant question is not How Much Should I Spend but how much will you be able to qualify for? In addition, the higher interest rate you will pay may also affect what you will be able to afford.

Regarding spending 1/10 of your income on a car, I agree that you would probably end up with a car that you will continue to pour money into. However, forget 20K as well. I drive a newer Scion XD that cost $15,200 brand new. It’s made by Toyota so the quality is great and I get 35 MPG combined in town driving which means I also save on gas. While 10K might not be doable, $15K certainly is.

7 Matt Jabs

Perhaps a still better question is not how much should we finance but how much can we afford if we were to pay cash?

Have we utterly abandoned the idea of actually saving and paying cash for something rather than borrowing, presuming upon future income, and signing on to be debtor for the next however many years?

8 wickedmess

“Maybe the more relevant question is not How Much Should I Spend but how much will you be able to qualify for?” ~ Treesje

Isn’t it that attitude that caused this mortgage mess? People buying homes that they qualified for but couldn’t afford?

Considering what interest rate Marlon will probably end up with, he would be far better off doing what he needs to to buy a reliable used car outright. (Get a 2nd job if need be.) There ARE reliable used autos out there and not adding to your debt is always a good idea.

9 wickedmess

Sorry, Matt, I guess we were posting pretty much the same idea at the same time!

10 H Lee D

@Trey — The length of time you would need to own a new car with better gas mileage to cancel out the monthly payments makes it not worth the difference, unless you’re going from something that gets 11 mpg to a Prius and you drive 200 miles a day.

You can get a safe, fuel-efficient used car for well under $20K.

Agreed that it’s easier for those with larger incomes to follow spending guidelines (in theory). For those of us making under $50K/year, a $20K car isn’t in the cards unless we save and save for it (or go into too much debt). That’s just part of the glory we call American capitalism. You can be bitter about it, you can accept and work with it, or you can change your income.

Fortunately, I don’t “need” an expensive car to be happy with my lot in life, and when I took a 3% pay cut this year (with a corresponding increase in benefits contributions/copay), I was sure glad I didn’t have to figure out how to re-budget to make my car payment. (I bought it cash five years ago.)

11 Matt Jabs

“Fortunately, I don’t “need” an expensive car to be happy with my lot in life, and when I took a 3% pay cut this year (with a corresponding increase in benefits contributions/copay), I was sure glad I didn’t have to figure out how to re-budget to make my car payment. (I bought it cash five years ago.)”

Beautifully put H Lee D.

12 Trey

I agree wholeheartedly, I don’t drive an expensive car either. I drive a 15yr old Ford Ranger which I paid cash for several years ago. It was well under $10,000 when I brought it, but still close to twice the 1/10th price suggestion. Cash is the way to go, I wouldn’t buy a new car or finance one but I also couldn’t see myself spending 1/10th my income on a replacement vehicle when/if I cross that bridge.

I am not recommending that Marlon go out and finance a 20k car without a down payment. I am just saying that depending on his income level, 1/10th of gross may not be completely adequate. Nevertheless, he shouldn’t overextend himself regardless.

13 Matt SF

I certainly don’t think the 1/10th rule is ridiculous, but I also think it’s a stretch that some people have the fiscal discipline to save that much money.

As for the car, I would begin investigating how much you get by selling the Cougar on the open market. If you think it’s a fair price, you could sell it, and use those funds as a down payment on a used car that fits your needs. This would make a potential creditor think you’re on the right path, and might give you that something extra for loan approval.

I would also try to lower your Debt to Income ratio and your monthly expenses as much as possible. By improving your cash flow, creditors will consider you a lower risk of default if you have extra money available every month.

It also wouldn’t hurt to open an account with a small regional bank, ask to see the loan manager, and advise him/her of your situation. Ask for advice on what you should do to become a better borrower (basically a “suck up” question), and perhaps return 6 months later to show you’re on the right path. Establishing a face with a loan application can’t hurt, especially if you’ve documented that you’re a better borrower on paper.

14 Financial Samurai

Marlon – Do you mind sharing how you got into bankruptcy in the first place?

Perhaps financing a nicer car right after coming out of bankruptcy is akin to an alcoholic buying a 6-pack right after coming out of rehab?

Sometimes cars make guys go crazy. I know, I’ve had 7 in the past 10 years. We come up with ANY excuse to justify our need for another car.

Use the 1/10th rule as a guideline. Either get motivated to make more money, or reduce your desires. It is the disillusionment that one deserves more than one can really afford that gets us all in financial trouble in the first place.

Good luck!

15 FernWise

I’d need to know both what caused the bankruptcy and what makes the Cougar unsafe. As others have noted, if consumer debt lead to the bankruptcy then going for yet more debt is a bad idea – there is no reason to believe that you’ve changed your lifestyle and values.

And that makes me wonder what makes the Cougar ‘unsafe’. And why you bought and drove a car for a year that you felt was unsafe. And why any lender lent money on an unsafe car, and why an insurance company covered an unsafe car.

To too many of my clients, when I worked at Consumer Credit Counseling, felt that the only way to be safe on the road was to own the biggest car on the road, or the newest car on the road. Thus I’m worried you mean that the Cougar is in good mechanical shape but you want a Big Honking SUV of some sort, just because it’s a Big Honking Vehicle or want a shiny new car because you feel that any car over a certain number of years old is defacto ‘waiting to die’.

Both of those ideas are, in my never humble view, fallacies. In fact, our ‘newer’ car, bought used and for cash, is a ’99 Ford Contour. Smaller even than your Cougar. It gets us where we are going, it is FAR from the largest car on the road, and it’s never going to help our 22 year old impress women into glitz. Thus it is made of Win.

16 Matt Jabs

“…it’s never going to help our 22 year old impress women into glitz. Thus it is made of Win.”

LOL! 🙂

17 Four Pillars

I think the 1/10 rule is way too simplistic. The fact is that if you buy a car for only $5k you are guaranteed much higher repair bills then a more expensive and newer car.

I’m not saying you should buy a brand new car to save on repair bills but I think someone who doesn’t make a ton of money (ie <$50k) will quickly find out that their "10%" car could soon be their "15%" or "25%" car after a few big repair bills.

18 H Lee D

I disagree that you are “guaranteed” anything. I bought my car cash for $4K five years ago and have paid way less in maintenance that I would have in payments plus maintenance if I had decided to buy a cheap new car instead. (New cars get maintained, too.)

Also, to my thinking (not sure if Matt would agree or not), if you have $15K saved up for the purpose of buying a car, then it doesn’t matter what your salary is — go buy a car for $15K. But if you are doing it all through financing then you need to consider if it’s more important to have a new(er) car or to do other things that you enjoy doing that cost money (assuming you have disposable income). I’d rather go out on the weekends and drive an older car and not have debt, but I am clearly not in the majority.

19 Financial Samurai

One of the greatest scams around is “maintenance” and “repair costs” propagated by the car industry. You don’t need to change your oil every 3,000 miles, nor do you have to get a new transmission.

I have a very close friend who is an automechanic, who has told me a ton of secrets.

This isn’t the 80’s folks. Cars build in the 90’s and later are much more dependable than they were.

20 Matt Jabs

“(New cars get maintained, too.)”

Precisely. We must always remember that ALL vehicles will have maintenance costs… not just used/older vehicles (which I’m pretty sure Four Pillars is quite aware of, just didn’t mention).

Regarding the saved $15k – absolutely. If one has that much saved for the purposes of buying a vehicle, then by all means… go buy it. BUT – If that same person has not fully funded their yearly retirement savings, has high interest debt, or has some other *fundamental* money right they should take care of first… then they should use a portion of those savings for that before spending it on a car – IMHO.

21 Four Pillars

I didn’t say “maintenance”, I said ‘repair bills’ – there is a difference.

I also didn’t say that an older car (with extra repairs) will cost as much as a new car. My point is that it will cost more than the “10%”.

22 DC@Dollarcommentary

First of all, on the whole safe vehicle thing; Of course, if your brakes don’t work, then your car isn’t safe, but really, a car is a car is a car. Unless you’re driving a behemoth known as a Hummer or some other massive SUV, then that car you’re driving is really only as safe as any other car (exempting those new tiny little 1-person Nissan things).

It seems cars are always an issue with people who otherwise are very smart with their money. There’s just something about cars and the American culture that cause people to think irrationally.

And the whole 1/10th rule, it’s just a suggestion everybody, don’t take it to heart if you don’t want to. The only thing I have to say about it is that typically cars can be found for a bit cheaper than what people usually think.

23 Robert Espe

A brand new Nissan Versa is under $10k. If you bought it at all used, it would be very cheap indeed. No matter what car you buy, budget at least $1000/yr for maintenance.

Another thing to think about. “Normal” cars put on about 20k miles/yr. Cars have an intended lifespan of about 10 years/200k miles (as indicated by the maintenance schedule). So any car with under 200k miles is still fine even if you aren’t a super-mechanic. Start your search with cars that are half way though their life (5 years, or 100k miles, right where too many people get rid of them) and I think you will find the 1/10th rule more manageable than you think.

24 BG

My advice is to repair what you own, and pay it off. Due to the bankruptcy, you should stay to a cash-only basis for a while…

25 Peter

Personally I think way too many people justify large auto loans on the premise that their car is “unsafe” or that because their car is older there will be a ton of repair bills. The fact is – there are a lot of good reliable older cars that you can buy, without breaking the bank – and that have great reliability. Take my wife’s car for example. It’s an 8 year old Honda Civic. It has had next to zero maintenance or repair costs in all the years we’ve owned it since buying it used, and it is extremely safe with front and side airbags – and great gas mileage as well. It still has many good years left. My car is a 2006 Chevrolet Impala. I bought it with cash in 2008 for less than 10k – with 30,000 miles on it. That car has also had zero maintenance costs beyond regular oil changes and tires.

I think the 10% rule is a good one – and it’s about what we used when buying our cars.. Don’t be fooled folks, there are plenty of good cheap reliable cars out there, you just need to do your research.

Also – if you save up an emergency fund – you’ll be ready if you do have a repair bill for your older car. Even with a few hefty repair bills you’ll still end up paying less than you would for a new car.

26 BG

I agree with Peter. A few months ago, I spent $900 on repairs for my ’97 Ranger (current Bluebook value around $1,500). I have already broken-even on that repair bill, versus a typical car payment.

The repairs were for new calipers, wheel cylinders, pads, wheel bearings, shocks, etc — all warranted to last at least 30k miles, and some of the parts to last 60k miles (or life). I see nothing stopping me from driving this truck for another 10 years — as long as it stays properly maintained. A big maintenance item that people neglect on cars is the transmission fluid (about a $100 job) — replace that fluid as dictated by the owners manual or you will have some severe transmission costs, upwards of $2,000.

If in the market for a used car, try to find one with under 80k miles specifically because of the transmission neglect — and immediately have it serviced to bring the maintenance up-to-date (if the previous owner didn’t provide the records).

27 LeanLifeCoach

Why not keep the cougar? Virtually all cars today are built with the same uni-body construction and will protect you in all but the most serious accidents. In those, there are few cars that will help.

Save the money and drive it into the ground!

28 Типа

класс)мне понра)особенно!

29 Атлет

moskvasoset i ne ebet!

30 All Rights Reserved

Шикарно, возьму в дневник

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