What Happens to My Car Loan if I File Bankruptcy?

Filing for bankruptcy significantly impacts financial obligations, including car loans. Understanding how bankruptcy interacts with secured debts like vehicle loans is important. The outcome for your car loan depends on the type of bankruptcy filed and choices made during the process.

Initial Effects of Bankruptcy on Your Car Loan

Upon filing for bankruptcy, the automatic stay immediately takes effect. This legal injunction temporarily halts most collection activities by creditors, including efforts to repossess your car. The automatic stay prevents lenders from seizing your vehicle or making collection calls, offering a window to determine how to proceed with the car loan.

The automatic stay applies regardless of whether you file for Chapter 7 or Chapter 13 bankruptcy. It is a temporary measure, and a lender can ask the court to lift the stay if their interests are not adequately protected, such as if you stop making payments. You must disclose all assets and debts, including your car and its loan, in your bankruptcy petition.

Managing Your Car Loan in Chapter 7 Bankruptcy

Chapter 7 bankruptcy, often called liquidation bankruptcy, offers distinct options for handling a car loan. These include surrendering the vehicle, reaffirming the debt, or redeeming the vehicle. Your choice depends on your financial situation and desire to keep the car.

Surrendering the Vehicle

Surrendering the vehicle means voluntarily giving up the car to the lender. This action discharges the car loan debt, including any deficiency balance if the car’s sale proceeds are less than the outstanding loan. The decision to surrender is noted in a “Statement of Intention for Individuals Filing Under Chapter 7 Bankruptcy” form, freeing you from future obligations for that debt.

Reaffirming the Debt

Reaffirmation involves signing a new agreement with the lender to continue making car loan payments, essentially taking the debt out of bankruptcy discharge. This allows you to keep the car, provided you remain current on payments, but it reinstates your personal liability. You remain responsible for the loan even after bankruptcy, and defaulting later could lead to repossession and liability for any deficiency.

Redeeming the Vehicle

Redemption allows you to keep your car by paying the lender its current fair market value in a single lump sum, rather than the full outstanding loan balance. This option is beneficial if you owe significantly more than the car is worth. The remaining loan balance, beyond the car’s fair market value, is then discharged as unsecured debt. Obtaining the lump sum payment often requires new financing, which can come with higher interest rates.

Managing Your Car Loan in Chapter 13 Bankruptcy

Chapter 13 bankruptcy, known as reorganization bankruptcy, provides a structured approach to managing a car loan through a court-approved repayment plan. This process allows individuals with regular income to retain assets, including their vehicle, while addressing debts over three to five years.

A car loan is usually incorporated into the Chapter 13 repayment plan. Your regular car payments, along with other debts, are consolidated into a single monthly payment to a bankruptcy trustee, who then distributes funds to creditors. This allows for potential adjustments to payment terms or interest rates, making the loan more manageable.

Curing Arrears

Chapter 13 offers a mechanism to cure past-due car payments, known as arrears. These missed payments can be spread out and paid over the life of the repayment plan, preventing repossession as long as you adhere to the plan and continue making current payments. This feature benefits those who have fallen behind on their car loans but wish to keep their vehicle.

Cramdown

A “cramdown” is another option available in Chapter 13 for car loans. If your car was purchased more than 910 days (approximately two and a half years) before filing for bankruptcy, you may reduce the principal balance of your car loan to the vehicle’s current fair market value. The difference between the original loan balance and the reduced value is reclassified as unsecured debt, which may be partially or entirely discharged upon completion of the plan. This can lead to lower monthly payments and savings, allowing you to pay off the car by the end of the bankruptcy.