Can I Keep Two Cars in Chapter 7 Bankruptcy?

In some cases, you can keep two cars when you file for Chapter 7 bankruptcy. But you'll need to be able to protect all of your vehicle equity using a bankruptcy exemption. Also, if you're making car payments, must be current on the loan, and you might have to show that you can afford to continue making the payment without causing undue hardship on yourself and your family.

Can You Protect the Equity in Two Cars?

When you file for Chapter 7 bankruptcy, you agree to give up certain property in exchange for a discharge of debt (an order wiping out your obligation to pay for qualifying debt, such as credit card balances, medical bills, and personal loans). But you won't give up everything you own.

Even so, determining whether you can keep property in bankruptcy is a multistep process. First, you must figure out whether you have a right to keep your vehicle equity. Here's how it works.

• Find out how much property you'll be able to protect. Each state decides which property its residents will need to maintain employment and a home. You'll find the property you can protect in the exemption laws. There are two sets: state and federal exemptions. Some states allow filers to choose between the state exemptions and the federal exemptions, but in most states, you'll use the state exemptions.
• Calculate your vehicle equity. Research the value of the cars. Subtract any car loans or liens that you'd need to pay if you sold it. The amount remaining is the equity.
• Find out how much vehicle equity you can exempt. Most states let you exempt some equity in a single vehicle (although some will allow you to spread the exemption amount over multiple cars). You'll be able to protect more equity if your state has a wildcard exemption that you can use for any property of your choosing. If you're unable to exempt the full value of either vehicle, you might have to turn one or both cars over to the bankruptcy trustee appointed to your case. The trustee will sell the car, pay you the exemption amount, and use the rest to repay your unsecured creditors according to the bankruptcy priority payment rules.
• Decide if you want to buy back any nonexempt equity. If you pay the nonexempt portion (the amount you can't protect) to the trustee, you can keep the car. You'll have to use income you earn after the bankruptcy or borrow money from a friend or relative. However, the trustee might give you a discount due to the saved sales costs. (For more information, see The Motor Vehicle Exemption.)

Example. Ava owns two cars that she paid off long ago. One is worth $2,000, and the other $4,000. Her state allows her to exempt $4,000 in vehicle equity, leaving her with $2,000 of nonexempt equity. She must pay the trustee $2,000 (minus any discount allowed) to keep both cars.

Do You Have a Car Loan?

Determining whether you can protect the equity in your cars is just the first step if you still owe money on either vehicle. The next step involves making arrangements to continue to pay for the car. There are some ways to do this:

• redeem the vehicle (pay its value in a lump sum payment)
• sign a reaffirmation agreement (a new contract), or
• continue paying on the loan without the protection of a contract.

Here's how each approach works—as well as some problems you might encounter.

Redemption

If the fair market value of your car is worth less than what you owe, you can ask the court to allow you to pay the actual value in one lump sum payment. Redeeming the vehicle, as it's called, is rarely used for obvious reasons: Most debtors don't have the ability to come up with the funds. Your bankruptcy attorney might be able to direct you to a redemption lender, but be prepared to pay a high-interest rate.

Example. When Justin financed his car, he ended up with a high-interest loan due to his bad credit. When he later filed for Chapter 7 bankruptcy, his vehicle was underwater—he owed $10,000 on a car worth only $5,500. His mom agreed to give him the $5,500 needed to redeem the car in Chapter 7 bankruptcy. Justin's bankruptcy attorney filed the necessary paperwork and received approval from the judge.

Reaffirmation

A more common approach is signing a reaffirmation agreement (a new contract) with your lender in which you agree to continue making your regular monthly payments. Usually, your payments need to be current when you file for bankruptcy because your lender doesn't have to agree to include overdue payments in the reaffirmation agreement (but the lender might—but you can't count on it).

Also, you'll have to show the court the following:

• reaffirming the debt is necessary
• the payment amount is reasonable, and
• making the payment won't cause you or your family undue hardship).

So, you'll need to demonstrate that you need two cars and that the payments are affordable and reasonable under the circumstances. Expect the court to examine your income and expense schedules to determine whether there's sufficient room in your budget for the car payments.

Example. When David decided to file for Chapter 7, he was married to Olivia, but he filed alone to preserve Olivia's good credit. David had two car loans in his name—one for his car and one for Olivia's vehicle. The car payment on David's car was $300, and the car payment on Olivia's car was $250. Both spouses worked and needed separate transportation. They were able to afford the car payments without sacrificing other reasonable and necessary expenses, such as food and rent because their children had recently left home. The court approved reaffirmation agreements because the payments were reasonable and necessary and wouldn't cause undue hardship.

Paying the Lender Informally

Some lenders will allow you to keep a car as long as you remain current on the payment. The benefit is that if the vehicle gets damaged or repossessed, you won't be responsible for paying anything. However, without the protection of a contract, the lender could take the car back without warning. Some courts prefer that filers use this approach instead of taking on new debt immediately after bankruptcy.

For more on your options for dealing with car debt in Chapter 7 bankruptcy, see Chapter 7 Bankruptcy and Your Car.