What Happens to Your Car If You File Bankruptcy?

Individuals often wonder about the fate of their vehicle when contemplating bankruptcy. What happens to a car during bankruptcy proceedings depends on several factors specific to an individual’s financial situation and the type of bankruptcy filed.

How Car Ownership and Debt Affect the Process

The way a car is “owned” or possessed significantly impacts its treatment in bankruptcy. Ownership can be categorized into outright possession, a financed arrangement, or a lease, each carrying distinct legal and financial implications. The classification of the vehicle determines how it is addressed by bankruptcy laws.

Outright ownership means the individual holds the car’s title free and clear, with no outstanding loans or liens against it. In this scenario, the car is considered an asset belonging entirely to the individual. Its value contributes directly to the individual’s overall assets, which bankruptcy courts review.

A financed vehicle involves a secured debt, where the car itself serves as collateral for the loan. This means the lender holds a legal claim, or lien, on the vehicle until the loan is fully repaid. If the borrower fails to make payments, the lender has the right to repossess the car to satisfy the debt.

A leased vehicle is fundamentally different from ownership, as it is a contractual agreement for the use of a car for a specified period, not an acquisition of ownership. The leasing company retains ownership of the vehicle throughout the lease term. Consequently, a lease is considered an executory contract rather than a debt in the same way a car loan is.

Handling Your Car in Chapter 7 Bankruptcy

Chapter 7 bankruptcy, designed for liquidation, involves a bankruptcy trustee who reviews the debtor’s assets and debts to determine what can be used to pay creditors. The treatment of a car in Chapter 7 depends on whether it is owned outright or financed and its value relative to available exemptions.

Exemptions play a significant role in protecting a debtor’s property, including vehicles, from being liquidated. Laws provide specific exemption amounts for motor vehicles, allowing debtors to protect a certain amount of equity in their car. If the car’s equity (its market value minus any outstanding loan) falls entirely within the applicable exemption amount, the vehicle is not subject to sale by the trustee. However, if the equity exceeds the exemption, the trustee may sell the car, give the debtor the exempt amount, and use the remaining proceeds to pay creditors. The trustee evaluates the car’s value to determine its fair market value.

For vehicles with secured loans, debtors have three primary options in Chapter 7 bankruptcy: reaffirmation, redemption, or surrender.

Reaffirmation

Reaffirmation involves signing a new, legally binding agreement with the lender to continue making payments on the car loan. This option allows the debtor to keep the vehicle, but it also means remaining personally liable for the debt. The reaffirmation agreement must be filed with the court, and a judge may deny it if it appears to impose an undue hardship on the debtor.

Redemption

Redemption offers an alternative for debtors to keep a financed 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 when the debtor owes significantly more on the car than it is worth. The remaining balance of the original loan is then discharged as unsecured debt. Redemption requires immediate access to funds.

Surrender

Surrendering the vehicle to the lender is another option, which involves voluntarily returning the car and discharging the associated loan debt in bankruptcy. This relieves the debtor of any further financial obligation for the car loan, including any potential “deficiency balance” if the car sells for less than what is owed.

For leased vehicles in Chapter 7, debtors typically choose to either assume the lease, continuing payments under the original terms, or reject the lease and return the vehicle, discharging any future obligations. If the debtor is current on payments, assuming the lease allows them to keep the car.

Handling Your Car in Chapter 13 Bankruptcy

Chapter 13 bankruptcy, a reorganization bankruptcy, allows individuals with regular income to repay debts through a court-approved plan over three to five years. Unlike Chapter 7, debtors generally retain all their property in Chapter 13, including vehicles, as long as they adhere to the repayment plan. The car loan is typically incorporated into this repayment plan, providing a structured approach to managing the debt.

A significant benefit of Chapter 13 is the ability to cure arrearages, or missed payments, on car loans through the repayment plan. If a debtor has fallen behind on car payments, the Chapter 13 plan allows them to catch up on these overdue amounts over the plan’s duration while continuing to make regular ongoing payments. This prevents repossession and helps maintain transportation.

The “cramdown” option is a valuable feature in Chapter 13 for financed vehicles, particularly when the outstanding loan balance exceeds the car’s current market value. A cramdown allows the debtor to reduce the principal balance of the car loan to the vehicle’s fair market value. The difference between the original loan amount and the cramdown value is reclassified as unsecured debt, which is typically paid at a reduced rate or even discharged at the plan’s completion.

A key condition for applying a cramdown to a car loan is the “910-day rule,” which requires that the vehicle must have been purchased at least 910 days (approximately two and a half years) before the bankruptcy filing. This rule prevents debtors from immediately cramming down recently purchased vehicles. Additionally, the interest rate on the crammed-down loan may be reduced to a court-determined rate, which can be lower than the original contract rate.

For leased vehicles, Chapter 13 offers flexibility similar to Chapter 7, allowing debtors to either assume the lease or reject it. If the debtor chooses to assume the lease, missed payments can be included and cured through the Chapter 13 repayment plan. Vehicles owned outright are also protected in Chapter 13. While their value is accounted for in determining the feasibility of the repayment plan, the car itself is not at risk of liquidation by the trustee as long as the plan payments are made. The automatic stay, which goes into effect upon filing, provides immediate protection against repossession for all types of vehicles, offering a crucial period for the debtor to establish their repayment plan.