A charged-off car loan is like any other vehicle loan in bankruptcy. If the lender has already repossessed the car, or if you’re willing to turn it in, you can discharge (wipe out) the loan in your bankruptcy case.
Many people believe that once a loan appears as “charged off” on a credit report, they’re no longer responsible for the debt. This isn’t the case.
When you stop paying on your car loan, the lender has a limited amount of time to take the loan off of the books by transferring or selling your loan. Despite the transfer, you remain responsible for paying the balance to whomever currently owns the debt.
It’s important to list all charged-off loans in your bankruptcy paperwork so that you can obtain a discharge of the debt. You’ll characterize it as either a secured or an unsecured debt, depending on whether the car has been sold at auction (more below).
Most car loans are secured. A borrower agrees to secure a loan by pledging property that the lender can take back if the borrower fails to pay according to the contract terms. Doing so gives the lender a lien that allows the lender to repossess the vehicle, if necessary.
If you have a charged-off vehicle loan, but you still have possession of the car (or title is still in your name because the lender hasn’t sold it yet), then the loan balance is a secured debt. You’ll characterize it that way when you fill out your bankruptcy forms.
If the lender has sold the car (and the title isn’t in your name), then the loan balance is an unsecured debt. It’s not secured by the collateral any longer. In most states, a lender has the right to collect a deficiency balance—the difference between what you owe and the proceeds from the vehicle auction. You’ll list the deficiency balance as an unsecured debt.
In a Chapter 7 bankruptcy, if the car loan is still secured, then you’ll decide whether you want to keep the car or give it back to the creditor. If you keep it, you’ll either reaffirm the car loan (agree to keep making payments) or redeem the car (pay the value of the car in a lump sum). Here’s the tricky part: You usually can’t reaffirm a debt that is not current, and by definition, a charged-off debt isn’t current. So reaffirmation is a rare option.
It’s more likely that you’ll either redeem or surrender the car. Redemption works well if the car’s value exceeds what you owe, it’s in decent condition, and you can pay the car’s value in one lump sum payment. If you redeem the car, you would then own it free and clear after your bankruptcy case.
If you surrender the car, the creditor will take it back, sell it, and apply the sales proceeds to the loan. Any amount left owing gets discharged.
In a Chapter 13 case, you can pay the loan back over the life of the plan and keep the car, even if the debt has been charged off. A Chapter 13 can also help you get a car back that has been repossessed by the creditor. You’ll likely have to pay the full amount that is owed on the car if you bought it less than two and a half years before your bankruptcy filing date. Otherwise, you might be able to cram down the loan and pay only what the car is worth.
You can also surrender a car in Chapter 13. In that case, the lender will sell the car and apply the proceeds to the loan. Any unsecured leftover balance will receive a pro rata share (split among the unsecured creditors) of your discretionary income over the life of the plan.
In a Chapter 7 bankruptcy, almost all unsecured debts get discharged so you’ll no longer owe them after your case is over—including an unsecured charged-off vehicle loan. In a Chapter 13 bankruptcy, unsecured debts usually receive a portion of the balance paid out over the life of the plan. At the end of the case, you’ll receive a discharge of any remaining amount owed.
(Find out about other dischargeable debts in Which Debts Are Discharged in Chapter 7 Bankruptcy?)