Can You Declare Bankruptcy and Keep Your Car?

For many individuals facing significant financial hardship, the prospect of bankruptcy can bring concerns about retaining essential assets, particularly a car. While filing for bankruptcy involves complex legal processes, it is frequently possible for individuals to keep their car, though the specific path depends on various factors and the type of bankruptcy filed.

How Bankruptcy Types Affect Car Ownership

Bankruptcy proceedings offer different frameworks for addressing secured debts, such as car loans. A secured debt uses property, like a car, as collateral. Understanding how the two main consumer bankruptcy types, Chapter 7 and Chapter 13, handle these debts is crucial for anyone considering their options.

Chapter 7 bankruptcy is often referred to as liquidation bankruptcy. When a Chapter 7 petition is filed, an automatic stay goes into effect. The automatic stay temporarily halts most collection activities, including repossessions, but does not eliminate the secured lender’s claim on the vehicle. In Chapter 7, while personal liability for the car loan can be discharged, the lender’s lien on the vehicle remains. This means that to keep the car, the debtor must address the secured debt.

Chapter 13 bankruptcy, conversely, is a reorganization bankruptcy. It allows debtors to propose a court-approved repayment plan, lasting three to five years, to pay back debts. Car loans are commonly integrated into this structured payment plan. This approach benefits those with steady income who have fallen behind, allowing them to catch up on arrears and continue payments. The automatic stay also applies in Chapter 13, preventing repossession while the debtor proposes a repayment plan.

Methods to Retain Your Car

Individuals filing for bankruptcy have several methods to retain their vehicles, each suited to different financial circumstances. These methods depend on the type of bankruptcy filed and the debtor’s financial capacity.

In Chapter 7 bankruptcy, one common method is reaffirmation. A reaffirmation agreement is a new, legally binding contract between the debtor and the car loan lender, agreeing to continue making payments on the debt despite the bankruptcy discharge. This essentially removes the debt from the bankruptcy process, making the debtor fully liable for the loan. To be approved, the agreement requires court approval to ensure it does not cause undue financial hardship. If payments are not maintained after reaffirmation, creditors can still repossess the vehicle and pursue the debtor for any remaining balance after sale.

Another option in Chapter 7 is redemption. This method allows the debtor to keep the car by paying the creditor its current market value in a single lump sum, rather than the full outstanding loan balance. Redemption is useful when the amount owed on the car loan significantly exceeds the vehicle’s fair market value. The remaining balance of the loan, beyond the car’s market value, is then treated as unsecured debt and can be discharged. While requiring immediate cash, specialized lenders sometimes offer loans for redemption purposes.

For those in Chapter 13 bankruptcy, retaining a car is achieved by integrating the loan into the court-approved repayment plan. This plan outlines how the debtor will make regular payments to the Chapter 13 trustee, who then distributes funds to creditors. The “cramdown” option in Chapter 13 allows the debtor to reduce the secured portion of the car loan to the vehicle’s actual fair market value, with any remaining balance reclassified as unsecured debt. This unsecured portion is then paid at a reduced rate or discharged entirely at the plan’s conclusion. To qualify for a cramdown, the car loan must have been incurred at least 910 days (approximately 2.5 years) before the bankruptcy filing.

Finally, for vehicles that are fully paid off, bankruptcy exemptions play a role in retention. Both federal and state laws provide exemption amounts that protect a certain amount of equity in a vehicle. If the car’s equity (its value minus any outstanding loan) falls within the applicable exemption limit, the debtor can keep the vehicle without trustee intervention. Many states also offer a “wildcard” exemption, which can be used to protect additional equity in a car if the motor vehicle specific exemption is insufficient.

Factors Influencing Car Retention

Several practical considerations and financial realities directly influence whether a debtor can keep their car during bankruptcy proceedings. These factors interact with legal methods to determine the most feasible path.

The amount of equity in the vehicle is a primary determinant. Equity is the difference between the car’s current market value and the outstanding loan balance. In Chapter 7, if the equity exceeds the allowed bankruptcy exemptions, the bankruptcy trustee may have the right to sell the car, use the proceeds to pay off the loan and creditors, and then return the exempt amount to the debtor. Conversely, a car with little or no equity, or even negative equity (owing more than it’s worth), is less likely to be taken by a Chapter 7 trustee.

Whether a debtor is current on car payments significantly impacts their options. Being current on payments provides more flexibility and a stronger position when seeking to reaffirm a loan or integrate it into a Chapter 13 plan. If a debtor is significantly behind on payments, the lender may be more inclined to seek relief from the automatic stay to repossess the vehicle, even if the debtor intends to catch up. However, Chapter 13 specifically allows debtors to cure payment arrears over the life of the repayment plan, providing a structured way to get current.

The debtor’s ability to make future payments is crucial, regardless of the retention method chosen. Reaffirmation agreements and Chapter 13 plans both require the debtor to demonstrate financial capacity to continue regular payments. Courts review reaffirmation agreements to ensure they do not impose an undue hardship, and Chapter 13 plans are built around the debtor’s disposable income to ensure feasibility. Without the ability to consistently meet these obligations, keeping the car becomes unsustainable.

The car’s value relative to its loan balance also influences the viability of certain options. For example, redemption in Chapter 7 is most advantageous when the car’s market value is substantially less than the loan balance, allowing the debtor to pay a reduced lump sum. Similarly, the “cramdown” option in Chapter 13 is designed for situations where the loan balance exceeds the vehicle’s value, enabling a reduction of the secured debt.

While the law provides options, the creditor’s willingness can sometimes play a role, particularly in reaffirmation agreements where the lender must agree to the new contract terms. Finally, bankruptcy exemption laws vary by state, which can impact how much equity in a car can be protected. Some states offer higher motor vehicle exemptions than others, and the availability of a wildcard exemption also affects car retention outcomes.