Will You Lose Your Car If You File Bankruptcy?

When individuals face overwhelming debt, bankruptcy offers a legal pathway to financial relief. A common concern for those considering bankruptcy is the potential loss of personal assets, especially their car. While it is a valid concern, losing a car is not an automatic outcome, depending on several factors. This article clarifies how a car is treated in bankruptcy.

Bankruptcy Types and Your Car

The type of bankruptcy filed influences how a car is treated during the process. The two forms of personal bankruptcy are Chapter 7, which involves liquidation, and Chapter 13, which focuses on reorganization. Each chapter has implications for a debtor’s vehicle.

In a Chapter 7 bankruptcy, a court-appointed trustee may sell non-exempt assets to repay creditors. If a car has significant equity that exceeds exemption limits, it could be sold by the trustee. Debtors with a car loan in Chapter 7 must decide whether to surrender the vehicle to the lender or attempt to retain it through legal mechanisms.

Chapter 13 bankruptcy involves a repayment plan that extends over three to five years. Secured debts, such as car loans, are incorporated into this plan, allowing the debtor to keep the vehicle as long as payments are made. For certain car loans that meet specific age criteria, a “cramdown” may be possible, allowing the debtor to reduce the principal owed to its current fair market value, potentially lowering monthly payments.

Protecting Your Car: Exemptions and Equity

Bankruptcy exemptions are legal protections that allow debtors to safeguard certain assets from being sold by a trustee to satisfy debts. These exemptions are governed by either federal or state statutes, and debtors choose one set of exemptions. Understanding how these exemptions apply to a vehicle is important for its protection during bankruptcy.

Motor vehicle exemptions protect a certain amount of equity in a car. For instance, the federal motor vehicle exemption allows a debtor to protect up to $5,025 in equity in one vehicle. If a car’s equity, calculated by subtracting the outstanding loan balance from its fair market value, falls within this protected amount, the vehicle is safe from liquidation in Chapter 7. If the equity exceeds the exemption, the unprotected portion could be sold by the trustee, unless other exemptions can be applied.

Beyond motor vehicle exemptions, a “wildcard exemption” can be used to protect additional equity in a car. This exemption allows debtors to protect any type of property up to a specified amount. For example, the federal wildcard exemption allows a debtor to protect $1,675 plus up to $15,800 of any unused portion of their homestead exemption. This flexibility can be used to cover additional equity if the motor vehicle exemption is insufficient. Cars with little to no equity, where the loan balance is close to or exceeds the vehicle’s market value, are at a lower risk of being taken by a Chapter 7 trustee, provided loan payments are current.

Options for Financed Vehicles

Debtors with car loans have several choices regarding their vehicle during bankruptcy proceedings. These options allow for different outcomes depending on the debtor’s financial circumstances and their desire to retain the vehicle. Each choice carries implications for the debtor’s future financial obligations.

One option is a reaffirmation agreement, a voluntary contract between the debtor and the lender to continue paying a secured debt even after the bankruptcy discharge. This agreement allows the debtor to keep the car, but it also means they remain personally liable for the debt, even if the vehicle is later repossessed or totaled. The court must approve reaffirmation agreements, ensuring that the debtor can afford the payments and that the agreement does not pose an undue hardship.

Another choice is redemption, a process where the debtor pays the lender the current market value of the car in a single lump sum. This effectively buys the car back, often at a reduced price if the loan balance is higher than the vehicle’s actual value. Redemption requires the debtor to secure new financing or have a significant amount of cash available, as the payment must be made in full.

Alternatively, debtors can choose to surrender the vehicle to the lender. This option eliminates the debt associated with the car loan, and importantly, it prevents the lender from pursuing a deficiency balance. A deficiency balance is the remaining debt after the car is sold if the sale price does not cover the full loan amount. Surrendering the vehicle provides a clean break from the financial obligation.