If you have pledged some item of personal property (other than real estate or non-business cars) that you already owned as security for a loan, and the property is completely or partially exempt, you may be able to eliminate a lien on the property. This is called avoiding the lien.
Nonpossessory, Non-Purchase-Money liens sounds complicated, but are easier to understand if you break the name down.
Nonpossessory means the creditor does not physically keep the property you’ve pledged as collateral. It stays in your possession; the creditor only has a lien on it. (In contrast, if you leave your property at a pawnshop to get a loan, that is a possessory security interest—for which this lien avoidance procedure is not available.)
Non-purchase-money means that you didn’t use the money you borrowed to purchase the collateral. Instead, you used property you already owned as collateral for the loan.
Security interest means the lien was created by voluntary agreement between you and the creditor. In other words, the lien wasn’t involuntary, like a tax or judgment lien.
How much of the lien can be eliminated depends on the value and type of property and the amount of the exemption. Here are the rules:
All equity is exempt. If the property (or your equity in it) is entirely exempt, the court will eliminate the entire lien, and you’ll get to keep the property without paying anything.
Some equity is exempt. If the property (or your equity in it) is worth more than the exemption limit, the lien will be reduced to the difference between the exemption limit and either the property’s value or the amount of the debt, whichever is less.
Example. A creditor has a $500 lien on Harold’s guitar, which is worth $300. In Harold’s state, the guitar is exempt only to $200. He could get the lien reduced to $100. The other $400 of the lien is eliminated (avoided).
Advantages. This type of lien avoidance costs nothing (if you are representing yourself), involves only a moderate amount of paperwork, and often allows you to keep property without paying anything.
Disadvantages. Some paperwork is involved. Also, by trying to avoid a lien on exempt property, you may reopen the issue of whether the property really is exempt in the first place. This may happen if the property was deemed exempt by default (that is, the property is exempt because the trustee and creditors didn’t challenge your claim of exemption within the applicable time limit). Some courts have allowed creditors to argue that the property is not exempt at a hearing on a motion to avoid a lien.
As a practical matter, however, motions to avoid liens are usually not contested.
There are several important limits on this type of lien avoidance.
First, as noted above, you may avoid only nonpossessory, non-purchase-money security interests.
Second, the property you pledged as collateral must be exempt under the exemption system you are using. If the property isn’t exempt, then the lien doesn’t impair your exemption rights, and it can’t be eliminated. (To learn more, see Bankruptcy Exemptions.)
Third, only certain types of property are covered. Unfortunately, the property most commonly pledged as collateral for nonpossessory, non-purchase-money security interests doesn’t qualify—homes and cars (unless the vehicle qualifies as a tool of the trade, discussed below). You may eliminate a nonpossessory, non-purchase-money security interest lien only if the collateral falls into one of these categories:
You can remove up to $6,225 of a lien from a vehicle that qualifies as a tool of your trade. Generally, a motor vehicle is considered a tool of the trade only if you use it as an integral part of your business—for example, if you do door-to-door sales or delivery work. It is not considered a tool of the trade if you simply use it to commute, even if you have no other means of getting to work.
To learn about avoiding other types of liens, and other ways to deal with liens, see the articles in Avoiding (Getting Rid of) Liens in Chapter 7 Bankruptcy.