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Can Bankruptcy Help with my Underwater Car?

Posted by attorney Clint Dunaway

Absolutely, bankruptcy can help if you owe more on your car than it is worth. Let’s take a look at how it can specifically help.

Chapter 7 – 722 Redemption:

Filing for Chapter 7 bankruptcy can allow you to reduce the amount you owe on your vehicle. Through a “722 redemption" you can seek a court order that allows you to pay your car loan company a lump sum payment equal to the market value of your vehicle. So for example, . Most people going through bankruptcy don’t have a lump sum amount to pay off their vehicle, however, there are several companies that do 722 redemptions and who will finance the lump sum payment. They will pay off your original loan and then you will make monthly payments to them.

How does the 722 Redemption work?

Under 11 U.S.C. 722 of the Bankruptcy Code you may redeem tangible personal property from a lien through paying the secured creditor a lump sum in a Chapter 7 Bankruptcy. In order to be eligible for a 722 redemption the property must be: 1) Tangible personal property intended primarily for personal, family or household use; 2) The secured claim must be paid a lump sum; and 3) The lump sum payment must be based on the current retail value.

If you wish to redeem your vehicle in a Chapter 7 bankruptcy then you need to apply for a 722 redemption loan. We closely work with several banks that can assist you in applying for one of these special loans. Typically, the interest rate is higher than normal due to the risk involved for the lender. Once you have received a 722 redemption loan and are in a Chapter 7 bankruptcy, a motion will be filed to redeem the vehicle. If the motion is granted by the court then the secured creditor will be paid a lump sum amount based on the current retail value of the vehicle. The secured creditor will then release the lien held on the vehicle.

Chapter 13 and the Car Cramdown:

If the amount of your car loan is greater than the value of your car, you might be able to reduce the amount of your loan and the interest rate in a Chapter 13 bankruptcy through a cramdown. Cramdown is a funny word that basically means you can reduce the amount you owe to equal the current value of the car. Whatever is left becomes unsecured debt, and is treated like your other unsecured debts.

Cramdowns are available in Chapter 13 bankruptcy only -- you cannot cram down a car loan in Chapter 7 bankruptcy. In a Chapter 13 bankruptcy, you propose a repayment plan to pay back your creditors over a three to five year period. In your plan, your attorney has the ability to propose that your car lender receive only the current value of your car instead of the current balance owed.

The unpaid portion of your loan is then treated as an unsecured debt. Other types of unsecured debt include credit cards and medical bills. Since most Chapter 13 plans pay little or nothing to these creditors, this means that your car lender will likely receive nothing or pennies on the dollar on the remaining balance of your loan. Upon completion of your bankruptcy, any unpaid balance on the car loan will be completely discharged and you will own the vehicle free and clear.

When you cram down a car loan in Chapter 13 bankruptcy, the law also allows you to lower your interest rate on the loan! In Arizona the interest rate will be determined by the current prime rate plus a little extra. Almost always this new interest rate is lower than your original car loan rate.

The bankruptcy code has placed an important restriction on when you are allowed to cram down your car loan. In order to cram down a car loan, you must have purchased your vehicle at least 910 days (about 2 ½ years) prior to filing your bankruptcy. If you are underwater on one or more of your vehicles let us show you how bankruptcy can help you.

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