When you file Chapter 7 bankruptcy and you have a car loan, you must indicate in your bankruptcy paperwork whether you intend to keep the car or give it back. If you want to keep it, you have to pay for it, and one of the ways you can do so is through reaffirming the car loan.
(To learn about your other options for car loans in bankruptcy, see Your Car in Chapter 7 Bankruptcy.)
Car Loans & Security Interests
When you take out a loan to buy a car, you give the lender a security interest in your car. What this means is that if you stop paying on the car, the lender can take the car to satisfy the debt.
What Is Reaffirmation?
When you reaffirm a car loan in bankruptcy, you sign an agreement with the lender that you will continue to pay for the car as if you had not filed bankruptcy, in exchange for keeping the car. To reaffirm a car loan, you must be able to show the court that the car is necessary and that the payment is reasonable. You must also be able to show that the car payment is not an undue hardship on your household.
If you sign a reaffirmation agreement and change your mind about keeping the car, you can rescind (cancel) the agreement. You must rescind within 60 days after you sign the agreement or before the court enters your discharge, whichever is later. If you rescind on time, you can give the car back without having to pay for it.
The Legal Consequences of Reaffirmation
Reaffirming a car loan means that you are agreeing to be responsible for the debt as if you had not filed bankruptcy. Once you receive your discharge, you are bound by the agreement unless you rescind it before discharge. The effect of reaffirmation is that you can keep your car as long as you keep making the payments. However, if you default on the payments, the lender can repossess the car and sell it at auction, and you will be responsible for any remaining balance due under the loan agreement, as well as auction fees.
Pros and Cons of Reaffirmation
The benefits of reaffirmation include:
- You secure your interest rate and payment. After a Chapter 7 bankruptcy, obtaining a car loan is not impossible, but your interest rates will be high, and you will likely only be able to obtain financing through a subprime lender. If you turn in your current car and need to finance a new one, you probably won't get terms as favorable as your old loan.
- You don't have to start over again with a new loan term. If you surrender your car in bankruptcy and had two years of payments left, you may have to obtain a new loan and start over again on a new term with a new car, which means more years of payments.
- You know what you're getting into. Reaffirming an existing loan means maintaining a relationship with the same lender and keeping the same loan terms.
Reaffirmation does have a major drawback, however. If you reaffirm the loan and miss payments after your bankruptcy is over, you will be liable for the loan. That means that if the lender repossesses the car and sells it at auction, you will be responsible for any deficiency balance and the auction fees. If you don't reaffirm the loan and surrender the vehicle, however, you are not liable for a deficiency balance -- it is wiped out in the bankruptcy. (Learn more about deficiency balances after car respossession.)
Example. Tricia reaffirmed the loan on her car in Chapter 7. Six months after her Chapter 7 discharge, Tricia defaulted on her payments. When the lender repossessed the car, Tricia owed $10,000. The lender sold the car at auction for $6,000 and incurred $300 in auction fees. Tricia is responsible for the $4,000 deficiency balance plus the auction fees.