Will I Lose My Car If I File for Bankruptcy?

Filing for bankruptcy doesn't mean that you'll have to give up your car. But it's not a given that you'll be able to keep it either. Being able to retain your vehicle in bankruptcy depends on the amount of equity, whether you can continue paying the loan (if any), and the bankruptcy chapter that you choose to file.

Protecting Your Car's Equity

When you file bankruptcy, you won't be left destitute. Each state decides which property its residents can safeguard with bankruptcy exemptions. The state's exemption list will cover key assets that you'll need to maintain a home and job, such as clothing, household goods, electronics, work tools, retirement accounts, and, in most cases, some equity in a homestead and equity in a vehicle.

Exemption amounts vary by state. Even so, because most people don't own high-status items such as recreational vehicles, boats, and luxury cars, bankruptcy debtors can often protect all—or at least most—property in bankruptcy. What happens to nonexempt property will depend on the bankruptcy chapter filed.

Paying Your Car Loan

Whether you can keep the car will also depend on whether you owe money on it. A car loan is a "secure" loan, which means that if you stop paying it, the lender can sell the vehicle at auction and use the proceeds to pay the balance—even if you file for bankruptcy. So, you'll need to be able to continue making your vehicle payments after filing, and, if you're behind on your payments, you'll have to find a way to bring them current (options discussed below).

Determining What Will Happen to Your Car

Each chapter offers different benefits. Once you understand that you'll have to pay for any car that you'd like to keep and you know how much equity you can protect, you'll be ready to decide which bankruptcy option is best for you.

For instance, Chapter 7 bankruptcy is an excellent choice for those who can protect all equity and are current on payments. Chapter 13 bankruptcy works well if you're behind on payments or you have a significant amount of nonexempt equity and would still like to keep the car.

Chapter 7 Bankruptcy

Your vehicle will be protected in Chapter 7 bankruptcy if you're able to exempt all equity and you own the car outright. If you can't exempt all of your equity, the bankruptcy trustee appointed to your case will sell the vehicle and distribute the proceeds to your creditors.

Some trustees will allow you to pay for the nonexempt equity at a discount (the value minus costs of sale) using one of the following options:

• borrowing money from friends or relatives
• taking out a high-interest loan (not advisable), or
• making payments with post-bankruptcy income over the course of a few months.

If you've financed your car, you'll need to take into account your car loan, too. You should be aware that a Chapter 7 case doesn't have a mechanism to catch up on overdue payments (see Chapter 13 bankruptcy below).

Here are your three choices:

• Surrender the car to the lender. If you can't afford the car payments, you can surrender the vehicle to the lender and discharge any balance you owe on the loan. This might be a good choice if your car is worth less than you owe or the interest rate is high.
• Reaffirm the car loan. You can keep the car if you're willing to continue making payments. You and your lender will sign an agreement called a reaffirmation agreement that essentially creates a new contract on the original loan terms. If you later decide to give up the car or you run into trouble with payments, you'll still be responsible for any deficiency balance that's left after the lender sells the car.
• Redeem the car for its value. If you have access to a pool of cash, you can pay the lender the actual value of the vehicle and any remaining balance will get discharged. Most lenders will require that you pay the value in a lump sum. Although there are companies that offer loans to finance a redemption, you'll likely be charged a high-interest rate, which could quickly eat into any savings.

The discharge (debt forgiveness) timeline in Chapter 7 bankruptcy is approximately four to six months.

Chapter 13 Bankruptcy

In Chapter 13 bankruptcy, you'll pay into a repayment plan that lasts for three to five years. Not everyone will qualify, however, because this chapter requires you to prove that you have enough income to pay the amount required by the bankruptcy rules (listing all requirements is beyond the scope of this article).

Here are the options under this chapter:

• Surrender the car. If you don't want to keep the car, you can let it go back to the lender. You'll likely pay a small portion of the balance in your payment plan. The remainder will get discharged with other qualifying debt.
• Pay your nonexempt equity in your payment plan. If you can't protect all of your equity, but you want to keep the car, you can pay for the nonexempt portion through your repayment plan.
• Continue making car payments. If you have a car loan and you're current, you can continue making your payments according to the terms of the loan outside of your Chapter 13 repayment plan.
• Add the car loan to a Chapter 13 payment. If you're behind on your payments, you can include either the arrearages or the entire car loan in the Chapter 13 plan (some jurisdictions make you include both when you're behind). Depending on the terms of your loan, this could allow you to stretch out and lower your overall payment.
• Reduce the car loan. If you had the car loan at least 910 days when you filed the Chapter 13 case, you might be able to adjust the terms of the loan to your favor. In a "cram down," you pay off the value of the car (rather than the balance of the note) as a part of your Chapter 13 payment plan. You can also cut the interest rate to around 5-6%, which works well when you owe more than your car is worth.

Learn more about the Chapter 13 process by reading Chapter 13 Bankruptcy Timeline.