Surrendering a Car in Chapter 7 Bankruptcy

If you have a car loan or a car lease when you file Chapter 7 bankruptcy, you must choose whether to keep the car and continue to pay for it or surrender it and discharge (wipe out) the debt. This article explains:

• how Chapter 7 bankruptcy works
• how to keep a financed car in Chapter 7
• the pros and cons of surrendering a vehicle, and
• a cosigner's responsibility after a vehicle surrender.

You'll also learn about the process involved, including how to inform the bankruptcy court and the car lender of your decision on the Statement of Intention for Individuals Filing Under Chapter 7 Bankruptcy form.

How Does Chapter 7 Bankruptcy Work?

Chapter 7 bankruptcy provides financial relief to qualified individuals struggling with debt. Once filed, the automatic stay stops most creditors from contacting you. While in place, those creditors cannot call you, send you bills or letters, or take other action to collect the debt. If you have a car loan when you file for bankruptcy, the creditor cannot repossess the car.

On average, you can expect the Chapter 7 process to take three to four months.

Meeting Qualification Requirements

Not everyone is entitled to a Chapter 7 discharge. Your household income can't exceed the state median income for a family of the same size. If your gross income is less than this amount, qualifying is simple. Otherwise, you'll have a second opportunity to pass the means test. In that portion, you're able to subtract necessary expenses—including taxes, mandatory payroll deductions, and childcare—from your income to see if you pass.

Wiping Out (Discharging) Debt in Chapter 7 Bankruptcy

Many of the debts that plague the average consumer will go away. For instance, you'll be able to wipe out utility bills; medical debt; personal loans, such as payday loans; and major credit card and department store balances.

You won't be able to get rid of everything, however. You'll remain responsible for any nondischargeable debt, such as balances on secured credit accounts commonly used by stores that sell jewelry, electronics, furniture.

Here are a few other obligations that you'll remain responsible for:

• income taxes incurred during the prior three years
• domestic support obligations, such as child or spousal support, and
• student loan obligations.

Protecting Property in Chapter 7 Bankruptcy

A person who files a bankruptcy (a debtor) doesn't lose everything. A debtor can keep (exempt) the property allowed by the debtor's state. In most cases, it will include:

• some equity in a residential home
• clothing and household belongings
• a modest car (usually determined by the amount of equity in it), and
• an ERISA-qualified retirement account.

You'll find exempt property listed in your state exemption statutes. Property that isn't covered by an exemption is called "nonexempt" property. The bankruptcy trustee—the official who administers the case—will sell the debtor's nonexempt property and distribute the sales proceeds to creditors.

How to Keep a Financed Car in Chapter 7 Bankruptcy

If you want to keep your car in Chapter 7 bankruptcy and have a car payment, protecting the equity is the first step. You'll also need to be caught up on the payment and be able to continue making the payment after your case ends. Many people surrender when the car payment is too expensive to maintain. Find out about more options by reading Chapter 7 Bankruptcy and Your Car.

Pros and Cons of Surrendering Your Car

Whether surrendering your car is a good idea will depend on your particular financial situation. Here are a few points to consider.

Pros. The benefits of giving up a car in bankruptcy include:

• You can walk away from it owing nothing, which is beneficial if it's worth less than you owe or if it needs repair.
• You can reduce your expenses by giving up a costly car payment that you can't 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 surrendering your vehicle:

• You'll need to find another mode of transportation.
• If you buy a new car, it might be challenging to get financing, and if you're able to, your loan will likely come with a very high-interest rate because of the bankruptcy.
• You might end up with a car that isn't as reliable as the vehicle you turned in.

Process for Surrendering Your Car

You'll let the court and the lender know of your decision to let go of the car when you complete the bankruptcy form called the Statement of Intention for Individuals Filing Under Chapter 7 Bankruptcy. The creditor must obtain permission from the court before repossessing the vehicle by filing a motion asking the judge to lift the automatic stay or getting your agreement to do so. Otherwise, the creditor must wait until the case is over (and the automatic stay is no longer in effect) before repossessing the vehicle.

Once the court lifts the stay, the creditor can repossess the vehicle, or you can voluntarily turn the car into the creditor at an agreed location. The creditor will sell the vehicle at auction, but you won't be responsible for the balance if it doesn't sell for the amount you owe. The deficiency amount will get wiped out in your bankruptcy case.

Example. Jane has a luxury SUV that she can no longer afford because she became ill and can no longer work. Her car payment is $500 per month. When she files Chapter 7 bankruptcy, she surrenders the car and is no longer responsible for the car payment.

Surrendering a Car When You Have a Cosigner

If someone cosigned the loan, the cosigner would remain legally responsible for the deficiency balance—the amount remaining after auction—but not the entire debt. The cosigner will get credit for the amount the lender receives in the sale (minus allowed expenses).

Example 1. Edward purchased a new car two years ago. When he filed for Chapter 7 bankruptcy, he owed $12,000 on a car worth only $8,000. He indicated his intention to surrender the vehicle on the Statement of Intention for Individuals Filing Under Chapter 7 Bankruptcy form. The creditor and Edward's attorney signed a stipulation agreeing that the court could order the automatic stay lifted. Once issued, Edward turned the car into a local dealership. Edward wiped out all responsibility in the bankruptcy.

Example 2. The second example facts are the same; however, Edward's father cosigned the loan. The car lender sold the car at auction for $5,000, leaving a $7,000 balance due on the debt. Although Edward isn't legally obligated to pay the debt because it was discharged in his Chapter 7 case, his father remains responsible for the $7,000 deficiency. (As an aside, Edward's father could wipe out the deficiency in his own Chapter 7 case, assuming he could meet qualification requirements.)

Learn more about whether your cosigner will be liable for your debt if you file for Chapter 7 bankruptcy.