One of the benefits of bankruptcy is that you can get out from under an oppressive car loan or lease. And, unless you have an expensive luxury car that you own outright or a valuable antique, it’s not likely that you need to worry about losing the car in bankruptcy—but that’s not always the case.
Your particular options will depend on whether you file a Chapter 7 or Chapter 13 bankruptcy. Keep in mind that under either chapter, you’ll have to pay the car loan if you want to keep the vehicle. But in some instances, you might be able to pay something less than what you owe.
Your Car in Chapter 7 Bankruptcy
Chapter 7 bankruptcy takes about four months to complete and doesn’t require you to enter into a repayment plan with creditors. You also get to keep, or “exempt,” a certain amount of property.
In exchange for forgiveness (discharge) of your qualifying debts, you agree to turn over all of your nonexempt property (assets not protected from creditors) to the court. The court sells the nonexempt property and distributes the funds to your creditors.
Almost every state allows you to exempt a particular amount of equity in a car (amounts vary from state to state). Your first step will be to determine whether you can protect all of the equity. If you can, and you don’t have a loan, your analysis is over—you get to keep the car.
If you can protect all of your equity and you’re paying on a car loan, or if you used the vehicle as collateral for another loan, you’ll have three choices: surrender the vehicle, reaffirm the debt, or redeem the car for the value.
- Surrender the car. If you don’t want to pay the loan secured by your vehicle, or if the car isn’t worth what you owe, you can give it back to the lender and walk away. Any loan balance you owe will get discharged in the Chapter 7 case. You can turn in a leased car and not be liable for further payments or other charges, as well.
- Reaffirm the car loan. If you choose to keep the car, you and the lender can agree to enter into a new contract called a reaffirmation agreement. You’ll continue making your payments until you’ve paid the loan off, usually according to the original terms when you filed the Chapter 7 case. If you stop making payments, the lender can repossess the vehicle and collect any amount remaining after selling the car at auction (called a deficiency balance). Also, if the car suffers damage in an accident that isn’t paid by insurance, you'll be responsible for it as if you had never filed bankruptcy.
- Redeem the car. If your car is worth less than you owe, but you want to keep it, you can pay the lender just the value of the car. However, there’s a catch: You’ll have to pay it in a lump sum. This might work if you can get a gift or loan from a friend or relative. Also, if you search online, you’ll find specialize in financing redemption of cars out of the bankruptcy. But the interest tends to be high, so you’ll want to be sure you’re getting a better deal than you would if you stayed with your original lender and reaffirmed the debt.
If you can’t protect all of your equity, go to “Unprotected Car Equity in Bankruptcy” below.
Your Car in Chapter 13 Bankruptcy
If you file for Chapter 13 bankruptcy, you’ll pay your disposable income (the amount remaining after paying allowed expenses) to your creditors for three to five years. You can use Chapter 13 bankruptcy to repay many different types of debt, including car loans. Here are some choices you and your attorney will consider.
- Surrender the car. Just like in Chapter 7 bankruptcy, if you give your car back to the lender and complete your Chapter 13 plan, the bankruptcy will discharge any remaining loan balance.
- Pay the loan outside of the plan. If you’re satisfied with the loan terms, and you're not behind on your payments, you can continue paying the car loan outside the plan as you would typically do.
- Pay the loan within the plan. If you’re behind on your car loan, or you want to stretch the balance out over a more extended period, making your payment in the Chapter 13 plan can help. For instance, you’ll likely be able to stretch out a shorter car loan to the full five years of the plan. Also, if you’ve had the car loan at least 910 days (two and a half years) when you file your bankruptcy, you might even be able to “cramdown” the loan amount. A cramdown lets you reduce the principal amount to the value of the vehicle and lower the interest rate to about 5% or 6%.
Unprotected Car Equity in Bankruptcy
It’s not uncommon to have more equity in your car than you can exempt from bankruptcy. That doesn’t necessarily mean that you’ll lose the vehicle, however. Again, your options will depend on the bankruptcy chapter you file.
- Chapter 7 bankruptcy. Suppose that you have $10,000 in equity in your car, but your state’s vehicle exemption is $5,000. Typically, the bankruptcy trustee appointed to administer the case would sell the car, pay off any loan, and distribute the remaining funds to creditors. Keep in mind that if you want to keep the car, most trustees will let you pay for the nonexempt equity at a discount (they’ll subtract sales costs) over a few months’ time. Filers often borrow the money from a friend or relative or use post-bankruptcy income to make the payments.
- Chapter 13 bankruptcy. You don’t have to give up property in a Chapter 13 case. However—just as in a Chapter 7 case—you must pay your creditors an amount equal to the nonexempt vehicle equity. Therefore, if you want to keep a car that has more equity than you can protect, you’ll pay for the nonexempt equity in your three- to five-year repayment plan.
Most people can’t afford to lose their car in bankruptcy. Because understanding the interplay between equity and car loans can be difficult, it’s prudent to seek the advice of a local bankruptcy attorney.