Credit’s Bad, But Need to Refinance

June 9th, 2011, by

Q: I just finalized my bankruptcy, and my attorney referred me to a lender who helps folks like me get a car loan. I purchased a 2006 Jeep Liberty with 60,000 miles for $12,500 and my interest rate is 18 percent. My car payment is $408 a month. My credit score right now is 560. I would like to refinance my car loan as quickly as possible, but I know I have to increase my credit score first. What is the fastest way to do that? My online research suggests that I need to pay all my bills on time and get a secured credit card with a bank that reports to all three of the credit agencies on a regular basis. I am already paying all my bills on time. I bank with Wachovia, and they said they offer such a card, but I would need to open the account with $300. If I obtain a secured credit card with a $300 limit and charge $45 every month and pay it off before the due date, will this help speed up the credit building process?

Roswell, GA

A: Can I take a step back with you before I answer your question about refinancing the car?

I, of course, don’t know why you filed for bankruptcy. Maybe you got into unmanageable debt by no fault of your own. Or perhaps you, like many Americans, lived above your means.

I don’t know why you needed to get another car. Was it possible to hang on to your hoopty? If you didn’t have a car, could you have carpooled or taken public transportation until you saved up for a lower-priced used car?

Even without your backstory, I would not have recommended you go into debt so soon after the bankruptcy. I wouldn’t have purchased a $12,500 car. I certainly wouldn’t have taken out a loan for 18 percent. Your attorney did not do you a favor. In fact, I wonder why he would have such a cozy relationship with a lender that he’s referring bankruptcy clients, who just got out of debt.

Certainly the lender is taking on risk lending you money, but not enough, in my opinion, to justify the rate you got. As of the last week in May, the average national interest rate on a used car with a 48-month term was 4.81 percent. It was 3.91 percent for a new car. Compare that with the rate you got and the lender is making out pretty darn good. And that lender and your bankruptcy attorney know you’re a better risk to collect the debt because you can’t file for bankruptcy for another eight years.

If I had been you, I would have scraped together whatever cash I could get and bought whatever car I could get for the money. You can still find a decent car for less than $12,500. People do all the time. The last thing you needed to do was to take on new debt, which, by the way, would have lowered your credit scores.

But you’re not me and you’ve asked my advice on how to refinance.

So what you are doing is going to help. You are paying your bills on time. You’ve gotten a secured credit card. You’ve used it. And, as you point out, it’s important not to charge more than some experts say 30 percent (not 20 percent) of the available balance. In fact, you don’t actually have to use the card anymore. You’ve charged enough to establish you can use it and pay the money back.

Now how long will it take your credit scores to rise?

No one really knows for sure. The inside box of how certain actions (paying bills on time, establishing good credit habits) affect your credit scores are complicated and not revealed to the public. But based on what I’ve seen with others, you should see your score moving up within the year.

After about a year, check various lenders, including your own bank, to see what interest rate they may offer you on a refinancing. Also include a credit union, which often has lower rates than banks.

Last modified: June 13, 2011 at 10:50 am