How to file for bankruptcy and keep your car: Chapter 7 and 13

There are options to prevent your vehicle from being repossessed if you are considering filing for bankruptcy? Even if you haven’t fully repaid your auto loan, many states — and the federal government — allow you to redeem or reaffirm your loan, and you may be able to avoid repossession of your car through bankruptcy code exemptions. However, laws, and caps on the vehicle’s equity, vary from state to state.

How to keep your car through Chapter 7 bankruptcy

Car loans are secured debt, meaning the car is pledged as collateral to back the loan. Because the car serves as collateral, it can be repossessed by the lender if you fail to maintain payments.

Under Chapter 7, the most popular bankruptcy for individuals, you have a few options for hanging on to your vehicle.

“To keep a vehicle while going through Chapter 7, the debtor has to be current and stay current with the lender, perform a ‘redemption,’ which involves paying off the lender, or perform a ‘reaffirmation,’ which can involve changing the loan terms. But this requires lender consent,” says Lamar Hawkins, a bankruptcy attorney with Guidant Law.

Here’s how redemption and reaffirmation work:

• Redemption: Pursuing redemption involves making one lump-sum payment to your creditor for the car’s current fair market value. If you can afford to do this, it may make life easier in the future since you’ll have eliminated car payments. Because most people file for bankruptcy at a time when cash is not readily available, this may not be possible.
• Reaffirmation: This option allows you to continue making payments on your loan as normal. When reaffirming your debt, you agree a second time to continue making payments according to a schedule agreed upon by you and your creditor, which may include revised loan terms.

“When you get a Chapter 7 Discharge, you will have no more personal responsibility to pay the loan,” says Pennsylvania-based bankruptcy attorney Dai Rosenblum. “All the creditor can do is take their collateral — your car. They can never sue you for money.”

Bankruptcy exemptions

When filing for Chapter 7, your assets are liquidated or sold to pay creditors. But a bankruptcy court allows you to keep a certain amount of your property up to a specific monetary value, according to Debt.org. This is called an “exemption.”

The federal exemption limit allows individuals to protect vehicle equity of up to $4,450. However, many states have an exemption limit that must be adhered to. Some states’ exemptions are more than $4,450, while others are less.

The value of your vehicle in a bankruptcy filing is not based on what you paid for it. In most states, value is tied to the car’s actual cash value, which depends on factors like the car’s year, make and mileage. Sources like Kelley Blue Book or Edmunds may also be used in determining your vehicle’s value.

If your car’s current value is less than your state’s exemption limit, then you will be allowed to keep the car. If the car is worth more than the exemption, a bankruptcy trustee may opt to sell the car to help pay your creditors.

Here’s how it works: If your state’s exemption is $4,000 and your car’s value is $2,000, you will likely be allowed to keep the vehicle because it’s worth less than the exemption. If, on the other hand, your state’s exemption level is $4,000 and your car is worth $10,000, then a bankruptcy trustee may sell the car and use the proceeds to pay off your debt.

Reasons you wouldn’t keep your car during Chapter 7 bankruptcy

Keeping your car may not always be possible when filing Chapter 7 bankruptcy. Plus, sometimes, it does not make financial sense to try and hang on to the vehicle. When sorting through these questions, your car’s value and your equity in the car play key roles.

The equity exceeds the exemption

Equity is determined by subtracting what you still owe on the car loan from the car’s current market value.

“For example, if you have a car with a fair market value of $10,000 with a $1,000 loan balance, you have $9,000 of equity,” says Rosenblum.

In this case, the vehicle’s equity exceeds the maximum federal exemption. Unless you can use the wildcard exemption rule, a bankruptcy trustee could choose to sell the car and apply the proceeds toward paying off your debts. If this happens, you will not be able to keep your car.

It doesn’t make financial sense to keep the car

If your vehicle’s current fair market value is less than what you owe on the car loan, keeping the vehicle is not necessarily a wise financial move. If you owe $5,000 on a car that’s worth $1,000, for example, keeping it could make you even worse off financially over time.

“Very often, the loan balance is greater than the value of the car, and without the means or desire to keep the vehicle, the filer lets it go,” says Michael Sullivan, a personal financial consultant with the nonprofit financial counseling agency Take Charge America.

How to keep your car through Chapter 13 bankruptcy

When you file for Chapter 13 bankruptcy, there are also several ways to keep your car.

“The Chapter 7 framework is the basis for Chapter 13,” says Rosenblum. “But in Chapter 13, you reorganize your debt.” This can take the form of a new payment plan or changing the terms of your loan, among other methods.

The process follows a standardized set of steps, but work with your lawyer to determine what actions you should take for your specific bankruptcy proceedings.

1. Create a payment plan

As part of Chapter 13 debt reorganization, a three- to five-year repayment plan will be developed that factors in your income and assets. The goal of the Chapter 13 process is to allow you to keep your possessions, including your car, while paying off your debt. Additionally, if you’re behind on payments, the plan will require you to catch up and make timely payments moving forward.

2. Revise the terms of the loan

The court may also require that the lender revise the car loan terms, including lowering the interest rate, which is another way to help you keep the car. With the revised terms, the monthly payments should be lowered.

“A rewrite of the debt owed to the lender can occur through a Chapter 13 plan, and market terms can be forced on a lender,” says Hawkins.

3. Reduce the loan balance

The process of altering auto loan terms as part of Chapter 13 may also include what’s known as a “cramdown,” which reduces the amount you must pay the lender to the car’s fair market value.

The timeline of your car loan origination is the most important factor in a cramdown. The 910-day rule will determine whether you keep your vehicle.

• Within 910 days: If you took out an auto loan within 910 days of filing for bankruptcy, you must pay the full value of the car loan. However, your interest rate may be reduced.
• More than 910 days: If you took out an auto loan more than 910 days before filing for bankruptcy, you are only required to repay the car’s current fair market value.

Reasons you wouldn’t keep your car during Chapter 13 bankruptcy

In certain circumstances, keeping your vehicle when pursuing Chapter 13 may be impossible. There are also scenarios where hanging on to the car may not make financial sense. This can include:

• If the loan is in arrears, and you do not have the financial resources to bring the loan current or the ability to make ongoing monthly payments. In this case, you may have to give up the vehicle.
• If the vehicle is not in good shape or is unreliable. Under these circumstances, simply giving up the car may make more sense.
• If the car is particularly valuable, and selling it would provide money to pay off your debts.
• If you have significant equity in the vehicle that exceeds the bankruptcy exemption levels in your state.

Bottom line

Filing bankruptcy does not automatically mean a car purchased with a secured loan will be repossessed, nor does it mean you’ll have to give it up as proceedings move forward. Several provisions protect your car under both Chapter 7 and Chapter 13 bankruptcy codes, although the terms and rules for these provisions can vary. Working with a bankruptcy attorney can help you decide which approach to bankruptcy makes the most sense for your financial situation.

If you’ve already gone through bankruptcy and need a new car loan, check out Bankrate’s top bad credit auto loan picks.