Can You File Bankruptcy on Car Loans?

Bankruptcy offers a structured legal process for individuals facing overwhelming financial challenges, providing a fresh start by reorganizing or discharging certain debts. Car loans are a significant financial obligation and a central consideration in bankruptcy filings. This article explores how car loans are addressed throughout the bankruptcy process.

Understanding Car Loans in Bankruptcy

Car loans are classified as “secured debt,” backed by the vehicle itself. Lenders hold a legal claim, or lien, on the car. If the borrower fails to make payments, the lender can repossess the vehicle. This differs from “unsecured debt,” like credit card balances, which do not have collateral.

The treatment of secured debt, including car loans, varies depending on the type of consumer bankruptcy filed. The two primary types are Chapter 7 and Chapter 13, each offering distinct approaches to managing financial obligations and collateral.

Under Chapter 7 bankruptcy, personal liability for the car loan can be discharged. However, the lender’s lien on the vehicle remains. While the individual is no longer personally obligated, the lender retains the right to repossess the car if payments are not continued. If the car has significant equity not protected by state exemptions, a bankruptcy trustee might sell the vehicle to pay creditors.

Chapter 13 bankruptcy involves a repayment plan spanning three to five years, allowing for the restructuring of car loan payments. Debtors can reduce the interest rate or principal owed through a “cramdown.” A cramdown applies if the car was purchased at least 910 days (approximately two and a half years) before filing, reducing the loan balance to the car’s current market value, with any remaining balance reclassified as unsecured debt. Under a Chapter 13 plan, debtors keep their vehicle while making payments through the trustee.

Options for Your Vehicle During Bankruptcy

When filing for bankruptcy, individuals have specific choices regarding their car loan and vehicle, each with distinct implications.

Reaffirmation involves signing a new, legally binding agreement with the lender. This agreement reaffirms the debtor’s commitment to continue making payments on the car loan, effectively removing that debt from the bankruptcy discharge. Choosing reaffirmation allows the individual to keep the vehicle and maintain payment history, but reinstates personal liability for the debt. If payments are not maintained after reaffirmation, the lender can repossess the car and pursue any deficiency balance.

Redemption allows the debtor to pay the lender the vehicle’s current market value in a single lump sum. This option is beneficial if the amount owed significantly exceeds the vehicle’s value. While it requires immediate funds, often through a “redemption financier,” it results in the debtor owning the car free of the original lien. The court must approve redemption, and payment typically occurs within 10 to 30 days after approval.

Surrendering the vehicle means voluntarily returning it to the lender. The entire car loan debt, including any potential deficiency balance after the vehicle is sold, is then discharged through the bankruptcy process. This eliminates the financial obligation and provides relief from burdensome payments. While it means losing the vehicle, it can be a practical solution for those who can no longer afford payments or whose car has negative equity.

Preparing for Bankruptcy and Your Car Loan

Careful preparation is necessary before initiating a bankruptcy filing, particularly when a car loan is involved.

Collect all relevant car loan documents. This includes the original loan agreement, recent payment history statements, and any documents related to the lien on the vehicle.

Accurately assess the vehicle’s current market value. Resources like Kelley Blue Book or the NADA Guide provide estimated values based on the car’s make, model, year, mileage, and condition. This valuation helps determine the equity in the vehicle, the difference between its market value and the outstanding loan balance.

Evaluate your financial situation. Determine your ability to consistently make future car payments if keeping the vehicle through reaffirmation or a Chapter 13 plan. The decision regarding the vehicle’s future—reaffirmation, redemption, or surrender—should be made before filing. This decision should align with your financial goals and practical need for the vehicle.

The Bankruptcy Filing Process and Your Car Loan

Once preparatory steps are complete, the bankruptcy filing process begins, with specific actions related to the car loan. Accurate financial reporting is paramount during this stage.

The car loan must be accurately listed in the bankruptcy schedules, formal documents submitted to the court. This listing includes the lender’s full name, the account number, the amount owed, and the vehicle’s current value.

A significant event is the 341 Meeting of Creditors, where the debtor meets with the bankruptcy trustee and any attending creditors. During this meeting, questions regarding the car and the chosen option—reaffirmation, redemption, or surrender—may arise. The debtor will formally state their intentions for the vehicle.

Executing the chosen option involves distinct steps. For reaffirmation, the debtor signs an agreement requiring court review and potential approval, formalizing the commitment to continue payments. Redemption typically involves filing a court motion to approve the amount, followed by a lump-sum payment to the lender. For surrender, the debtor notifies the court and the lender of the decision to return the vehicle, and arrangements are made for possession. After discharge, the car loan obligation is finalized based on the chosen option.