When you file a bankruptcy case, you have some options for handling your car and your car loan depending on whether you choose a Chapter 7 bankruptcy or a Chapter 13 repayment plan. Read on to learn about exemptions, reaffirmation, redemption, and Chapter 13 “cram down.”
Protecting a Car You Own Outright
Bankruptcy isn’t designed to leave you destitute. When you file a bankruptcy case, you’re allowed to protect (exempt) particular types of property up to certain values. The types and amounts of vehicle exemptions vary according to the state where you live (an exemption could be anywhere from $1,000 to $20,000). Most states allow an exemption for at least one car; some allow for more.
If your car equity is higher than the amount of the exemption, the trustee in a Chapter 7 case will sell it to pay some of your other debts (you’ll get the exemption amount back). If you can’t protect the car with an exemption, the bankruptcy trustee (the official who oversees your case) might agree to let you pay for the nonexempt amount. In a Chapter 13 case, any nonexempt amount can be added to your plan payments and paid over the life of the plan.
(Learn more by reading Keeping Property Using Bankruptcy Exemptions: You Don't Lose Everything.)
Surrendering Your Financed Car
Suppose, however, that you don’t have any equity in your vehicle and you can’t afford the monthly payment. In a bankruptcy case, you have the option to surrender your car to the creditor. If you give the car back, the bankruptcy will wipe out (discharge) any amount that you owe at the end of your case.
Understand, however, that bankruptcy doesn’t help you keep a car without paying for it. When you bought it, you agreed to pledge the car itself as collateral for the debt. This agreement creates a “lien” that allows the creditor to take the vehicle if you don’t pay as agreed. Bankruptcy doesn’t wipe out the lien, so if you want to keep it, you must continue to pay for it.
Keeping Your Financed Car After Bankruptcy
If you have a car loan, and you intend to keep your car after you finish your bankruptcy case, you have two options: reaffirm the debt or redeem the car for its fair market value.
Reaffirming the Car Loan
If your payments are current or nearly current when you file a Chapter 7 case, and you want to keep the car, most lenders will expect you to sign a document called a reaffirmation agreement. A reaffirmation is a new contract with the bank. If you fail to make your payments (default on your loan) after the bankruptcy is over, the vehicle lender will be able to repossess the vehicle and sell it. If the vehicle doesn't sell for the amount that you owe, and a balance remains, the lender will be able to collect the remaining amount (called a deficiency balance) from you.
You must sign and file the reaffirmation agreement before the court enters your bankruptcy discharge. If your bankruptcy paperwork shows that you can’t afford the payment (or if you file it without an attorney), you’ll have to attend a court hearing. At the hearing, you’ll need to convince the judge that you’ll be able to make the payments even though your paperwork shows that you can’t afford to do so.
Redeeming Your Car for Value
Instead of making payments on a car loan, you can agree to pay the creditor the value of the car. Redeeming the car can save you a lot of money, especially if you owe more than what the vehicle is worth.
Although this can be a money-saver, but there’s a catch. The lender will usually expect you to pay the value in a lump sum, which is hard for most debtors. Some debtors borrow the money from generous friends or relatives. Others use a commercial lending service that caters to debtors who want to finance their vehicles out of bankruptcy. The financing option usually carries a higher interest rate, and the debt won’t be discharged in the bankruptcy, but the loan can save hundreds or even thousands of dollars over the terms of a reaffirmation agreement.
The Chapter 13 Car Loan “Cram Down”
Chapter 13 bankruptcy requires you to pay into a repayment plan that lasts three to five years. You can use this chapter to manage your car payments along with other debts. You might even be able to change the loan terms to something more affordable.
Here are a few options:
- Pay your loan outside the plan. If you’re current, you can continue making payments directly to the creditor as if you had not filed a bankruptcy case.
- Stretch your payments out. You can include your car loan in your Chapter 13 plan. If you owe fewer than 60 payments, you can stretch out your loan balance (plus interest) over the entire length of the plan.
- “Cram down” the value and the interest rate. If you’ve had your car loan for at least 910 days (about 2 ½ years) when you file your bankruptcy case, you can propose a plan that will pay the lender the value of the car instead of the balance you owe on the loan. Also, you can reduce your interest rate to a reasonable “prime plus 1-2%.”
Example. Suppose that you’ve had your car loan for over 910 days. The principal balance on your vehicle loan is $15,000, and the interest rate is 18%. The actual value of the car, however, is $10,000. If you put your car loan into your payment plan, you will pay the value of $10,000, plus an interest rate of 5% to 6% (based on the Wall Street Journal prime rate as of May 2017). The rest of your balance, $5,000, will be treated as an unsecured debt like your credit cards, which you’ll pay only if your budget allows.
Questions for Your Lawyer
- I want to file bankruptcy. Are my cars exempt?
- I need my car to get to work. Will the court let me reaffirm the debt?
- Can I sell my car before I file for bankruptcy?