If you have a car loan or a car lease when you file Chapter 7 bankruptcy, you must choose whether you will keep the car and continue to pay for it or whether you will surrender the vehicle and discharge the debt. You indicate your decision to the bankruptcy court and to the car lender on the Statement of Intention. (Learn more about Chapter 7 bankruptcy's Statement of Intention.)
Here are the things you should consider if you do choose to surrender the car.
(If you want to hold onto your car, learn about your options for keeping your car in Chapter 7 bankruptcy.)
Legal Consequences of Surrendering Your Vehicle
When you file bankruptcy, an automatic stay goes into effect that prevents your creditors from taking any collection actions against you. While the stay is in place, creditors cannot call you, send you bills, send you letters or do anything else to collect on the debt. For a car loan, this means that the creditor cannot repossess the car. (Learn more in The Automatic Stay in Chapter 7 Bankruptcy.)
If, on your Statement of Intention, you say you plan to surrender the car, the creditor can either file a motion asking the judge to lift the automatic stay, or the creditor can obtain your agreement to lift the automatic stay. Once the court enters an order lifting the stay, the creditor can repossess the vehicle, or you can voluntarily turn the vehicle in to the creditor at an agreed location. The creditor may also simply wait until your discharge is entered and your case is closed and repossess the vehicle then, when the automatic stay is no longer in effect.
Once the creditor takes the car back, the creditor will sell the car at auction. Any difference between what you owed on the car and the sale price at auction (called the deficiency) is no longer your responsibility; that debt is included in your Chapter 7 discharge. However, if you had a cosigner on the loan, your cosigner will still be legally responsible for the debt. (To learn more about cosigned debt in bankruptcy, see Your Cosigner's Liability for Debt in Chapter 7 Bankruptcy.)
Example 1. Jane has a luxury SUV that she can no longer afford, since she became very ill and cannot work. Her car payment is $500 per month. She files Chapter 7 bankruptcy and surrenders the car, which allows her to use that $500 per month to pay for her medication and special diet.
Example 2. Edward purchased a new car two years ago. At the time, he owed more on his trade-in vehicle than it was worth, so he rolled the excess into his current loan. As a result, at the time he filed Chapter 7 bankruptcy, his car was worth $8,000 but his car loan was $12,000. He surrendered the car in his bankruptcy; the creditor and Edward's attorney signed an agreement to lift the automatic stay, and Edward turned the car in to a local dealership.
Edward's car lender sold the car at auction for $5,000, leaving a $7,000 balance due on the debt. Edward's Chapter 7 discharge means he is not legally obligated to repay that money. However, Edward's father, Jim, cosigned the loan. Jim is still responsible for the $7,000 deficiency, because Edward's discharge does not apply to Jim.
Pros and Cons of Surrendering Your Car
Whether surrendering your car is a good idea depends on your situation.
Pros. The benefits of surrendering a vehicle in bankruptcy are:
- You can walk away from the car owing nothing, which is very beneficial if the car is worth far less than you owe on it or if it is in need of repair.
- You can reduce your expenses by giving up a costly car payment that you cannot afford.
- You can give up a leased car without having to pay for excess mileage or wear and tear.
Cons. Here are some of the downsides to surrender.
- You'll need to find other modes of transportation.
- If you buy a new car, your loan will likely come with a very high interest rate because of your bankruptcy, and you may end up with a car that is not as nice as the one you turned in.
- It may be difficult to get a car lease or financing from a dealership. This means you may have to use a subprime lender. Not all subprime lenders are bad, but you will have to do research to avoid scams.