In general, it’s not a good idea to incur additional debt immediately prior to filing for bankruptcy. If you need to buy a car to get to work, whether you should purchase it before or after filing for bankruptcy depends on:
To learn more about what to consider before filing for bankruptcy, visit our Bankruptcy Filing Considerations topic area.
Below we discuss some of the benefits and drawbacks of buying a car with cash before filing for bankruptcy.
If you file for Chapter 7 bankruptcy, the court will appoint a bankruptcy trustee to administer your case and determine whether you have any property that should be taken to pay your creditors. Each state (and the federal system) has a unique set of bankruptcy exemptions that allows you to keep a certain amount of property in bankruptcy.
Most states allow debtors to protect a certain amount of equity in their cars with a motor vehicle exemption. But it’s typically harder to exempt the money in your bank account. As a result, if you can’t protect the cash you have in the bank (but you can exempt the value of the car you plan to purchase), it may be in your best interest to buy a car before filing your case.
There are drawbacks to buying a car with cash before you file for bankruptcy.
Exemptions may not protect the car. If your state doesn’t have a generous motor vehicle exemption, you may not be able to protect the car in bankruptcy.
Red flag for trustee. Restructuring your assets in a way that allows you to protect the maximum amount of property in bankruptcy is commonly referred to as exemption planning. In most cases, you can engage in a certain amount of exemption planning prior to filing for bankruptcy as long as it’s reasonable and in good faith. But if you have a lot of cash in the bank, using the money to buy a new car immediately before filing for bankruptcy can raise a red flag with the trustee.
In general, when determining whether your purchase was reasonable and in good faith, the court will consider:
For more information on how to maximize your bankruptcy exemptions, see our Prebankruptcy Planning topic.
The following are some of the advantages and disadvantages of taking out a loan to buy a car prior to filing for bankruptcy.
To qualify for Chapter 7 bankruptcy, your disposable income must be low enough to pass a bankruptcy means test. If you have a car loan, the means test allows you to take an additional car ownership deduction that is not available to debtors who own their cars free and clear or have no car at all. Similarly, the car ownership deduction can also lower your disposable income in Chapter 13 bankruptcy and reduce the amount you might have to pay unsecured creditors through your repayment plan. (To learn more, see Car Ownership Expenses and the Bankruptcy Means Test.)
As a result, taking out a car loan before filing for bankruptcy may allow you to qualify for Chapter 7 bankruptcy or pay less towards your unsecured debts in Chapter 13 bankruptcy. In addition, if you have good credit, you will likely get a better interest rate on a car loan before you file for bankruptcy.
While buying a new car on credit can lower your disposable income on the means test, it will also raise a red flag with the trustee (especially if you could not qualify for Chapter 7 bankruptcy without the new loan). If you obtain a loan to buy a car shortly before filing for bankruptcy, the trustee will question you regarding your purchase to make sure you didn’t buy the new car just to reduce your disposable income for bankruptcy purposes.
If you can’t convince the trustee that you had a valid reason for buying the car (for example because you didn’t have a car or your old car was not reliable), he or she might object to your discharge in Chapter 7 bankruptcy or argue that you should be paying more to your unsecured creditors in a Chapter 13.
Here are some of the pros and cons of buying a car after filing for bankruptcy.
If you buy your car after completing your bankruptcy case, you will not have to answer any questions from the bankruptcy trustee about why you purchased a car immediately before filing for bankruptcy. In addition, you will not have to worry about exempting the value of your equity in the new car in bankruptcy.
Many debtors are concerned about whether they will be able to finance a car after they file for bankruptcy. In general, you can still get approved for a car loan shortly after filing for bankruptcy. But your interest rate will likely be higher.
Also, if you plan to file for Chapter 13 bankruptcy, keep in mind that your repayment plan will last three to five years. If you want to take out a loan to buy a car while you are in Chapter 13 bankruptcy, you will need to file a motion and obtain court permission before doing so.