People often wonder how Chapter 7 bankruptcy will affect their ability to keep their car. If you aren't making payments on a car, then you'll be able to keep it if its value falls under your state's vehicle exemption amount. However, if you are making payments on your car, it's not so simple. During your bankruptcy, you'll need to decide whether you want to surrender the vehicle or keep it by continuing to make payments. You let the bankruptcy court know what you want to do by filing an official form called the Statement of Intention (SOI) with your other bankruptcy papers, as well as mailing a separate copy of the SOI to your vehicle lender. Similarly, if you are leasing your car, you can either reject the lease on your SOI or can keep the car by assuming the lease.
(To learn about all your options, see Nolo's section on Your Car in Chapter 7 Bankruptcy.)
Walking Away From the Car
If you want to walk away from the car when you file Chapter 7 bankruptcy, you list the lender on your SOI and state that you intend to surrender the vehicle -- that is, turn it in to the lender. This will clear you of any further liability on the debt after your bankruptcy. If you are leasing your car, you can get out of the lease by rejecting the lease on your SOI.
Keeping a Car You're Still Paying For
If you want to keep a car you are making payments on, no matter what else is going on in your bankruptcy, you should continue to make your payments as scheduled. You do have a choice, however, on how to keep the car: You can either pay the lender a lump sum to purchase the car at its current value (called redemption), or enter into a new contract (called a reaffirmation agreement), which lets you keep your car under much the same terms as your original car's promissory note (although this is negotiable).
Sometimes your lender will let you keep the car without entering into a reaffirmation agreement, by simply allowing you to continue to make the payments under the old agreement (this is called the ride-through option). If your lender has been accepting your payments, it's a sign that you may be able to retain the vehicle and continue making payments without entering into a new reaffirmation agreement.
Negotiating With the Lender to Keep the Car
To find out whether your lender will require a new contract after you file for bankruptcy, call them and ask for the bankruptcy or loss mitigation department. Explain that you intend to file for bankruptcy and ask whether you need to reaffirm the promissory note or can instead retain the car and continue making payments without reaffirming.
If the lender agrees to let you retain the car and pay according to the old agreement, the lender will still have a lien and can repossess the car if you default on your payments. But if the car is repossessed (or if you decide to give it back), you won't have to worry about still owing a deficiency on the car (the amount of the loan minus what the lender can sell the car for) -- that will be wiped out after your bankruptcy case is over.
If the lender requires you to reaffirm the promissory note and you do reaffirm it, consider carefully whether you want to do this. The lender will have a right to repossess the car if you default on your payments and you will owe any deficiency that remains on your loan if that happens. If you want to reaffirm your loan, you'll take the following steps.
Negotiate the Reaffirmation Agreement
First, you'll state on your Statement of Intention that you intend to reaffirm the promissory note. Then, the lender will send you an agreement setting out the same or similar terms as your old agreement. At this point you should consider negotiating the terms more to your advantage. You do have some leverage here, because the lender knows that bankruptcy gives you the option of surrendering the car and canceling all liability. Lenders lose a lot of money on repossessions, so they have an incentive to cut you a better deal, such as reducing the principal of the loan to the car's current value. Don't be afraid to attempt to negotiate for this. All the lender can do is say "No." If the lender does say "No," you may want to consider surrendering the car at this point, and let the bankruptcy erase your liability for the remaining payments on the loan.
Have the Court Review the Reaffirmation Agreement
Once you and the lender have agreed on the terms of the reaffirmation agreement, you'll sign the agreement and file it with the bankruptcy court. At the "discharge hearing," near the end of your bankruptcy, the judge will decide whether the agreement should be enforced. After considering your income, the amount you owe on the car, and its value, the judge may decide that the reaffirmation will create an undue hardship for you or be against your best interests. If you still owe much more than the car's value, a judge might disallow the reaffirmation.
What Happens If the Judge Approves the Reaffirmation
If the bankruptcy judge approves the reaffirmation agreement, you will continue to be liable under its terms after your bankruptcy ends. For instance, if you have to give the car back due to a loss of income, at a time when you owe $25,000 under the agreement and your car is worth only $10,000, you'll be on the hook for the $15,000 deficiency. Remember that because you can't file another Chapter 7 bankruptcy for eight years, you could be back where you started before you filed for bankruptcy (another reason why a judge might not approve the reaffirmation in the first place).
What Happens If the Judge Disapproves the Reaffirmation
If the bankruptcy judge disapproves the reaffirmation agreement, you don't necessarily lose the car. According to several bankruptcy court opinions, you can keep the car as long as you remain current on your payments. These courts reason that as long as you do what is required of you by the bankruptcy code (state your intention to reaffirm, sign and file the reaffirmation agreement, and attend the discharge hearing), the fact that judge disapproves the agreement is beyond your control and should not result in your having to give up your car. All of this is conditioned, of course, on staying current on your payments. (See In re Moustafi, 371 Bankruptcy Reporter 434 (Bankr Ariz 2007).) You can read this case at http://nydivorcefirm.com/wp-content/uploads/2014/08/moustafi.pdf. Paradoxically, if the judge disapproves the agreement, you will probably be better off, because you will be left with the practical equivalent of the ride-through option, meaning that you won't owe a deficiency should the car have to be surrendered or repossessed.
Want More Information?
To learn more about redeeming and reaffirming secured property in a Chapter 7 bankruptcy, see How to File for Chapter 7 Bankruptcy, by Stephen Elias, Albin Renauer, and Robin Leonard (Nolo).