If You Are Behind in Your Car Payments, Can Chapter 7 Help?

Filing for Chapter 7 bankruptcy will wipe out your responsibility to pay the car loan. But there are no free rides. If you want to keep the car and avoid repossession, you'll have to make arrangements to pay for it.

The problem is that Chapter 7 bankruptcy doesn't provide a way to catch up on overdue car payments the way that Chapter 13 does. However, Chapter 7 bankruptcy can stave off the repossession temporarily, which might give you time to make other arrangements.

(Learn how to catch up on car payments in Chapter 13 bankruptcy.)

Chapter 7 Will Temporarily Stop a Repossession

If you are behind on your car payments and you file for Chapter 7 bankruptcy, your lender cannot legally repossess your vehicle. When you file for bankruptcy, the automatic stay goes into effect and prevents almost all of your creditors from continuing with any collection actions, including repossessions or foreclosures.

Once you file, you or your attorney should immediately notify your lender so it stops all collection actions (the court will notify your lender of the bankruptcy, but it might take a few days or more).

The automatic stay is not absolute. Your car lender can ask the bankruptcy court to "lift" (remove) the stay as to the car loan. If you are behind in your car payments and don't have a lot of equity in the car, the court will likely lift the stay. If that happens, the lender can continue with collection actions against you, including repossession of your vehicle.

You Must Pay for the Car If You Want to Keep It

Even though Chapter 7 bankruptcy will wipe out your car loan, it doesn't have a mechanism for repaying overdue car payments. So filing for Chapter 7 bankruptcy alone won't help prevent an eventual repossession of the car if you don't make arrangements to pay. Here's why.

When a lender agrees to make a car loan, it takes steps to ensure that the loan will get repaid by requiring you to put the car up as collateral for the loan. Collateralizing the loan creates a secured debt.

A secured debt has two parts: (1) a contract that spells out your responsibility to pay back the loan; and (2) a document that gives the lender an ownership (security) interest in the car until you pay off the balance. The second legal instrument creates a lien. Because the lender has a lien attached to your car, if you fail to pay the loan, the lender can enforce the lien by repossessing your car.

Can You Protect Your Vehicle Equity?

If you want to keep the car, the first thing that you must do is determine whether you have any equity in the car, and if so, whether you can protect (exempt) it in bankruptcy. Most states allow you to protect the property that you'll need to maintain a household and job, including some equity in a vehicle.

You'll want to take a look at your state's exemption statutes and see whether the exemption amount will cover the equity—otherwise, you probably won't be able to keep it. The bankruptcy trustee appointed to your case will sell the car for the benefit of your creditors.

(To learn more, see The Motor Vehicle Exemption: Can You Keep Your Car in Chapter 7 Bankruptcy?)

Common Car Options in Chapter 7

Although it isn't easy to keep a car in Chapter 7 bankruptcy when you're behind on the payments, you have options. Here are a few:

• Give the car back to the lender. If you don't want to keep your car, or you realize that the payment is too much, you can surrender it to the lender. If you surrender your car during your Chapter 7 bankruptcy, you won't owe anything if the lender isn't able to sell it for what it's worth (called a deficiency balance).
• Buy a cheaper car later. If you're able to wipe out enough other debts, you might have an easier time-saving money to buy a more reasonable car after your bankruptcy.
• Negotiate a payment plan. Just because you can't make up car loan arrears in Chapter 7 bankruptcy, doesn't mean you can't try to get your lender to agree to accept some form of payment plan. In fact, the lender might agree to work out a new payment as part of a reaffirmation agreement. You should know, however, that if you reaffirm your car loan in bankruptcy, you're creating a new contract and you'll be on the hook for a deficiency balance. (To learn more see, Reaffirming Secured Debt in Chapter 7 Bankruptcy.)

Redeem the Car and Pay Less Than What You Owe

An option that that isn't used much is redemption. It allows the filer to pay the lender the replacement value of the property. This can work well if the property is worth less than what the debtor currently owes. There are some restrictions, however:

• the debt must be a consumer debt (taken out for personal, not business expenses)
• the property can't be real estate (a car is personal property)
• the property must be tangible (not intangible property, such as stock or publishing rights)
• the filer must be able to exempt all of the equity in the property, and
• the filer must pay the lender must in one lump sum payment.

Although this can be an excellent way to go, most bankruptcy filers don't have sufficient cash to cover the replacement value of the property. However, some lenders will redemption loans. If you're interested, talk with a local bankruptcy attorney.

(You can find out more by reading Redeeming Secured Property in Chapter 7 Bankruptcy.)