When you file for 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’ll have to pay for it, and one of the ways you can do so is to enter into a new contract with the lender in a process known as reaffirming the car loan.
(To learn about other car options in bankruptcy, see Chapter 7 Bankruptcy and Your Car.)
When you file for bankruptcy, you don’t give up everything that you own. You’re allowed to keep (exempt) property that you’ll need to maintain a job and household, such as clothing, household furnishings, and a modest car. In Chapter 7 bankruptcy, the bankruptcy trustee assigned to administer your case will sell any nonexempt property for the benefit of your creditors.
Therefore, the first step in determining whether you can keep a car is to decide whether or not you can protect all of the car equity. Each state has a set of bankruptcy exemptions that you can use to protect property from creditors. Some states allow you to choose between the state exemptions and the federal exemption scheme.
If you can protect all the car equity, you’ll have gotten over the first hurdle. But if you’re making payments on the car, there’s more to do.
When you take out a loan to buy a car, you give the lender a security interest—or a lien—in the vehicle. The lien allows the lender to take the vehicle to satisfy the debt if you stop paying on it.
Filing for Chapter 7 bankruptcy wipes out the contract that obligates you to pay the car lender, but the lien remains. So once the bankruptcy case is over and the automatic stay lifts (the order that prevents creditors from collecting debt), the lender will be able to repossess the car. Also, a lender that wants the car sooner can file a motion asking the court to lift the automatic stay while the case remains active.
Because of these rules, if you want to keep the car, you’ll need to make arrangements to continue paying for it.
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 it. To reaffirm a car loan, you must be able to show the court that the vehicle is necessary and that the payment is reasonable. You must also be able to show that the car payment isn’t an undue hardship on your household (you’ll still be able to afford the necessities of life).
(Find out more about the steps you’ll need to take to keep your car, including the reaffirmation process, in Your Car in Chapter 7 Bankruptcy.)
The benefits of reaffirmation include:
Reaffirmation does have a significant drawback, however. If you reaffirm the loan and miss payments after your bankruptcy is over, you’ll be liable for the loan, including any deficiency balance remaining after the lender repossesses the car and sells it at auction. If you don't reaffirm the loan and surrender the vehicle, however, you won’t be liable for a deficiency balance—it will be wiped out in the bankruptcy. (Learn more about deficiency balances after car repossession.)
Example. Chloe reaffirmed the loan on her car in Chapter 7. Six months after her Chapter 7 discharge, Chloe defaulted on her payments. When the lender repossessed the car, Chloe owed $10,000. The lender sold the car at auction for $6,000 and incurred $300 in auction fees. Chloe is responsible for the $4,000 deficiency balance plus the auction fees.
In some jurisdictions, the lender will allow you to continue paying on the car without entering into a reaffirmation agreement. In this situation, you wouldn’t be responsible for a deficiency balance if you weren’t able to continue making payments. However, without a contract, the lender could repossess the car at any time, even if the loan was current.
You can find out the practices allowed in your court by consulting with a local bankruptcy lawyer.