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Keeping your car in bankruptcy

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Filing for bankruptcy can be a last-resort option that you face if you’re struggling financially. However, assets under your name, including your vehicle, might be impacted while you undergo bankruptcy.

Whether it’s the only reasonable way to get to and from work or it’s necessary to care for an elderly parent who lives a few hours away, a car is an essential item for many people. If you want to learn how to declare bankruptcy and keep your car in the process, keep reading.

What type of debt is a car loan?

Unlike credit cards and many personal loans, a car loan is a secured debt. Secured loans require collateral. In the case of an auto loan, the collateral is the vehicle itself.

When borrowers are unable to afford their auto loan payment and fall into default, lenders can legally repossess the collateral on the loan (i.e., your car). Generally, lenders aren’t required to give advance notice of repossession if your loan is in default. If your repossessed car is sold, the lender may apply the proceeds toward your outstanding loan debt.

How to deal with your car loan bankruptcy

There are a few options to consider if you have a pre-bankruptcy automobile loan with an outstanding balance.

1. Reaffirm your current car loan

Lenders take one of two positions with a car loan in bankruptcy. The majority require that you complete a court-approved reaffirmation agreement. This is a legal, enforceable contract filed with the bankruptcy court and signed off by the judge. It states your promise to repay all or a portion of a debt that may otherwise have been subject to discharge in your bankruptcy case.

Some lenders demand that you sign this agreement and will not send you statements or report payments to the credit bureau without the court-approved agreement. In many instances, lenders consider it a breach of the terms of your loan and will repossess the vehicle if you fail to sign the agreement.

2. Keep the car and continue making payments

Some lenders allow you to keep making payments and not complete a reaffirmation agreement. You will need to make sure that payments are current, and you may not receive monthly statements after your case is filed. It will be up to you to call the lender and determine when the balance is paid off.’

3. Redeem the car loan with a new lender

Bankruptcy law permits a car owner to reduce the current car balance to the car’s fair market value. For example, if you owe $15,000 and the car is worth only $10,000 then you may be eligible to reduce the car balance by $5,000 with a new, post-bankruptcy loan.

A motion to redeem the car loan requires judicial approval. You will apply for the loan with the new lender and that lender will provide a new car loan offer. Then you will file a motion, along with the offer, with the court. The current car lender will either agree or disagree with the new car loan value. At that point, you will either reach a settlement on the value between the two lenders or will wait for a judicial decision on the fair market value of the car.

4. Negotiate directly with the lender

A few lenders will work with you and lower the balance to the fair market value without you needing to redeem the vehicle. Credit unions are the most likely to offer this service. Most lenders do not, but it is worth inquiring with the lender once you file.

Before and after filing, you must keep your car payments current unless you intend to surrender the vehicle.

5. Surrender the vehicle

As a final option, you can turn in the vehicle directly to the lender. Get something in writing to prove that you surrendered it. Until then, make sure to keep your car insurance current while the car is in your possession. You don’t want to compound your financial troubles with a post-bankruptcy-filing car accident. That debt will not be dischargeable in your bankruptcy if it occurs after the filing.

Once you surrender the car, the lender will sell it, usually for less than the amount you owe. The remaining balance, called the “deficiency balance,” should be eliminated in your bankruptcy.

Auto loans in Chapter 13 bankruptct

Options for how to declare bankruptcy and keep your car can depend on the kind of bankruptcy you’re filing.

Under Chapter 13 bankruptcy, you would continue paying off some of your owed debt in a reorganization or restructuring. For an outstanding car loan balance, you would repay the debt as part of a repayment plan, but the total amount repaid depends on how old the car loan is.

  • Newer car loans. If the vehicle loan is less than 910 days old, you must pay the full value of the car loan. However, there is a chance under the bankruptcy guidelines that the interest rate could be reduced, which might lower the monthly payment.
  • Older car loans. If the car loan is older than 910 days, the courts could give you a prorated payment amount based on the car’s fair market value.

If you are already behind on auto loan payments, you may be able to work out an additional financial arrangement with the auto lender.

Auto loans in Chapter 7 bankruptcy

With Chapter 7, also known as liquidation, you would give up assets in exchange for being able to walk away from certain debts. In general, people with car loans can consider the five options discussed above, which include:

  • Reaffirming the debt.
  • Redeeming the car.
  • Continuing repayment to make the loan current.
  • Renegotiating the loan terms with the lender.
  • Surrendering the car.

When filing for Chapter 7 bankruptcy, the goal is to get your debt back to a “clean slate.” Depending on your situation, you may or may not be given the option to keep your vehicle in the process.

The bottom line

No bankruptcy is easy, but if you have a car loan, it is possible to find a more manageable debt situation after you’ve filed. Take a look at your options and work with your bankruptcy attorney to determine the best alternative for your bankruptcy automobile loan.

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Written by
Jennifer Calonia
Contributing writer
Jennifer Calonia is an L.A.-based writer and editor. She's covered topics like debt, saving money and credit cards. You can find her work on Business Insider, Forbes and more.