Most people don’t jump into Chapter 7 bankruptcy without giving it plenty of thought—and with good reason. Filing for bankruptcy can require lifestyle changes that you might not be ready to make. For example, it isn’t always easy to let go of the luxurious things you can no longer afford, such as a boat, timeshare, or recreational vehicle. But the fact that doing so will result in wiping out a significant amount of debt usually lessens the sting.
Even so, it’s common to want to keep your house, car, or both. And, you can—as long as your payments are current and your state allows you to “exempt,” or retain, all of the equity in the property. But if you don’t meet these requirements, the consequences can be harsh: You stand to lose your house or car. There’s another option, however. You might be able to keep them by filing for Chapter 13 bankruptcy, instead.
If you don’t go down the Chapter 13 road, read on to learn how staying in a Chapter 7 bankruptcy might enable you to keep your car or home.
Mortgages and Car Loans Are Secured Debt
Anytime your creditor has the right to take back your property—such as your house or car—you have a “secured” debt on your hands. For example, your mortgage is a secured debt, and your house is the collateral that secures the mortgage. As you probably already know, if you fall behind on your payment, your lender can foreclose on your home. The same holds true for your car loan. If you don’t pay it, your creditor will repossess the collateral, your vehicle.
The consequences of failing to pay a secured debt are more extreme when compared to not paying unsecured debt, such as a credit card balance. The reason is simple. The lender stands to lose a larger amount of money. To make sure you’ll repay the balance, you’re required to pledge “collateral”—property that secures the debt—and the agreement to do so creates a “lien” on the property. The lien gives the creditor the right to take the property back if you “default”—don’t make good—on your promise to pay the obligation.
How Do I Keep Collateral in Chapter 7 Bankruptcy?
To keep a car or house that serves as collateral in Chapter 7 bankruptcy, you must be able to meet the following requirements:
- your loan must be current, and
- your state’s exemption laws must allow you to exempt all of the equity in the property.
Your Payments Must Be Current
Even though Chapter 7 bankruptcy temporarily stops your creditors from collecting against you, it doesn’t change the rules. At some point, your secured creditor can still take your property if you’re behind on your obligation.
Here are two ways your lender can reclaim your house or car:
- Your creditor can ask the court to lift the automatic stay—the order that stops your creditors from collecting against you in bankruptcy—and pursue foreclosure or repossession proceedings.
- Even if your creditor doesn’t try to lift the automatic stay, foreclosure or repossession proceedings continue against your property once the bankruptcy ends.
If you don’t want to risk losing your house or car, you’ll want to make sure that your payments are up-to-date before filing for Chapter 7 bankruptcy.
You Must Be Able to Exempt all of the Property’s Equity
It’s important to be sure that you can protect all of the equity in your home or car when trying to keep it in Chapter 7 bankruptcy. The exemption laws in each state determine how much equity you’ll be able to “exempt” (protect). If you have more equity than you can protect, the bankruptcy trustee—the person responsible for finding assets for your creditors—will sell the property, give you the amount you’re allowed to exempt, and distribute the balance—the nonexempt portion—to your creditors.
Example 1. Jack owns a car valued at $30,000 with an outstanding balance of $25,000. Because his state allows him to exempt $5,500 of equity in a vehicle, he can adequately protect the car and will not lose it in bankruptcy (as long as he continues making the payments after bankruptcy).
Example 2. Jennifer owes $150,000 on a house valued at $250,000. Her state’s exemption statute allows her to exempt $75,000 in the house. If Jennifer files for Chapter 7 bankruptcy, she’ll lose the home because the trustee will sell it, give her the first $75,000, and distribute the remaining $25,000 to her creditors.
Example 3. Suppose Jennifer is also $5,000 behind on her mortgage. She can keep her house if she files for Chapter 13 bankruptcy and pays $30,000—$25,000 of nonexempt equity and $5,000 in arrears—over a three- or five-year repayment plan.
(To find out how Chapter 13 bankruptcy can help you with secured debts, see “Secured Claims in Chapter 13 Bankruptcy: Can I Catch Up on My House or Car Payment?”)
When to Let Go
Even though you might want to hold on to a house or car, sometimes it doesn’t make financial sense. For example, suppose you owe $13,000 on a fifteen-year-old car that’s worth only $3,000. Paying $10,000 more than what a car is worth might not be the best use of your resources. You might want to let the car go back to the lender if you can borrow one while getting back on your feet, or if you have access to other forms of transportation, such as public transit.
Your Chapter 7 Bankruptcy Options
When you file a Chapter 7 case, you’ll tell the court what you want to do with the property serving as collateral for your debt on the Statement of Intention for Individuals Filing Under Chapter 7 form. You’ll have four choices:
- surrender (give back the property)
- reaffirm (enter into a new contract)
- redeem (pay the fair market value of the asset), or
To find out more about your options, see “Chapter 7 Bankruptcy: How to Keep or Let Go of Secured Property.”
Chapter 13 Bankruptcy Can Help
When you’re behind on payments, or when you have more equity than you can exempt, Chapter 13 bankruptcy can provide the solution you need. You might want to consult with a local bankruptcy attorney and find out if you qualify to make up arrearages, or pay for nonexempt equity, through a three- or five-year repayment plan.
Questions for Your Attorney
- I need my car, but it’s worth far less than I owe—what should I do?
- Will the trustee take into account how much it will cost to sell my home before deciding whether there’s nonexempt equity?
- Does it make sense to keep my house if the equity is upside down?