People are often concerned that they might have to surrender their assets to the court to be liquidated to pay creditors if they file bankruptcy. In reality, this only happens in a minimal number of bankruptcy cases.
Other debtors (the people who file bankruptcy) might be concerned about continuing to pay for the property that serves as collateral on debts they owe.
Find about your options and how you can keep your car (or not) after filing for bankruptcy.
What Options Do I have in Chapter 7?
Every car loan involves two agreements. The first agreement is the promissory note, which is the financial agreement between the lender and borrower. The lender gives a sum of money to the borrower, and the borrower agrees to pay it back.
The security agreement is the second part of the loan. Lenders need reassurance that they will get their money back. The borrower agrees to give the lender a security interest in collateral—often, this is property the borrower is purchasing.
If the borrower does not pay, the lender has the right to repossess and sell the collateral to get back at least a portion of what the borrower owes them.
At a minimum, the lender expects to get back the vehicle's value by selling it or receiving payments from you.
While a bankruptcy case generally discharges the debt, the security agreement remains in effect. When a borrower signs the loan paperwork for a car, it includes a section that effectually states that it is collateral. It can be seized and sold by the lender, even if bankruptcy is declared.
What can be done about the car loan? When you file Chapter 7, you have a minimum of three options:
- Surrender your car to the lender
- Reaffirm the debt
- Redeem it for its value
If you want to keep the car, your options are to continue making payments or pay your lender the vehicle's value.
Reaffirming the Debt
When you reaffirm your auto loan with the lender, you're agreeing to retake the loan and begin making payments. Reaffirmation of debt removes the protections the bankruptcy filing gave you on the debt you reaffirm. If you decide to let the lender repossess the car, your responsibilities to that loan and vehicle end.
However, if you reaffirm the loan, you're now fully responsible for the debt again. Reaffirming the loan may have some benefits—you might be able to negotiate a better rate to reduce your payments or the amount you owe on the vehicle.
Reaffirming or redeeming your auto loan puts you back in debt immediately after declaring bankruptcy. You should discuss your options with your attorney or a financial advisor before deciding.
Redeeming the Debt
Essentially, redeeming a car means you pay the lender the car's market value or the outstanding balance, whichever is lower.
When you redeem the car during bankruptcy, you pay the lender either the outstanding balance or the car's value, whichever is less.
This sounds good if you don’t owe much on the vehicle or owe more than the car is worth, which is true of many loans. However, in most states, you must pay the value to the lender in a lump sum. If you've just filed for bankruptcy, this might prove difficult.
Over the last several years, specialty online lenders have begun offering auto redemption financing. Redemption financing companies charge a relatively high-interest rate, but the new loan may be worth it if redeeming the original debt saves you money with the original lender.
Be wary of lenders that take advantage of bankruptees in need of financing. Watch out for predatory practices such as high additional fees, balloon payments or negative amortization—where the payments are so low you can't keep up with the loan's compounding interest.
It is also worth contacting other lenders, like your financial institution, where you keep your deposit accounts—especially if you didn't have any discharged debts from them during the bankruptcy.
Redemption is not rare, but it is usually not included in the standard fees a bankruptcy attorney charges. The attorney will probably ask for an additional fee because of the time and paperwork involved in vehicle redemption. If you chose to go through a redemption financing company, the new lender would often finance the additional attorney’s fee.
How to Redeem a Car in Chapter 7
There are some steps you should take if you decide to redeem your car:
- Determine how much your vehicle is worth. Two good places to look are NADA and Kelley Blue Book.
- Compare the value of your car with the amount your lender says you owe. If the value is significantly lower, it might be worth your while to pay off the loan or apply for redemption financing.
- Talk with your bankruptcy attorney about whether it is feasible for you to redeem your vehicle.
- Once you apply for financing, your attorney may have to do some negotiating with the original lender about the vehicle's value.
- Once you’ve come to terms with the lender, your attorney will prepare and file a Motion to Redeem with the court. The bankruptcy judge must approve the redemption.
- Once the court approves the redemption, the new lender will pay the old lender (and will pay your attorney any agreed-upon fee for handling the redemption).
Since the new loan was made after you filed bankruptcy, the new loan is not subject to the bankruptcy ruling. If you fail to make the payments as agreed, the redemption lender will have the rights available under its security agreement and state law to either repossess or force payment.