How to Handle Car Loan in Chapter 7 Bankruptcy
A major concern for many in Chapter 7 is how to handle a car loan. Should you keep the car (can you even keep it)? Should you turn it over? What other options do you have? Depending on what situation fits best, in Chapter 7 you can surrender the vehicle, reaffirm the debt, or redeem the vehicle.
SurrenderWhen you file Chapter 7 and have a car with a loan on it, you must complete the Statement of Intention, which informs the Court how you will handle the car and car loan. One option you have is to surrender the vehicle. You might choose this option if you are severely upside down on the loan, and you do not have the funds or resources to do a redemption.
Some bankruptcy filers are hesitant to surrender their car out of fear that the bankruptcy will scar their credit report. They fear it will scar the credit report so bad, it will be impossible to get another car loan, and thus the filer will be without a car for quite some time after bankruptcy. However, generally, the opposite seems true. After you file bankruptcy, you'll probably find lenders more willing to provide you a loan (although at a higher interest rate). This is because after your bankruptcy, there is less debt hanging over your head, so there's less chance you will default on the new car loan. Also, after you get a bankruptcy discharge, you cannot get another discharge for several years. So car lenders are encouraged by the fact there's a better chance to collect any loan deficiency from you if you happen to default on the new car loan.
Based on the above, many filers will gladly surrender their car to wipe out an upside-down loan, with the knowledge they can probably obtain another loan to get a new car once the bankruptcy is complete.
ReaffirmAnother option on the Statement of Intention is to "reaffirm" the car loan. This option might make sense if the bankruptcy filer has had the car for a few years and has built up equity in the vehicle (or even if the car value and loan value are close to even).
With the reaffirmation agreement, you usually agree to the same terms as the original agreement. Why sign a "new" agreement if you are just going to continue paying the same terms for the same car? The bankruptcy sort of nullifies the original agreement, but it does not remove the lien from the car. Without an agreement in place, the lender can satisfy the lien by repossessing (even though you filed for bankruptcy protection). However by requesting a reaffirmation, you are asking the lender to hold off on any repossession. As long as you are current or not too far behind on the original loan, the lender will likely agree to the reaffirmation. This is because with reaffirmation, in exchange for keeping the car, you agree to remain personally liable for the car loan, even after your bankruptcy discharge.
Why not negotiate lower terms (reduced balance, lower interest rate, etc.) when doing a reaffirmation? You can try to ask for lower terms, however it is unlikely the lender will agree. This is because the lender is not required to enter into a reaffirmation agreement with you. Thus there is no real leverage for you to try and lower the terms. However, the lender has the leverage of repossessing the car if no agreement is reached. So the lender will not be eager to accept any terms less than what was in the original agreement.
RedeemThis option is useful if you have a lump sum of money and you're far under water on the car loan. As long as you immediately pay the lender (usually through the trustee) the value of the car in one lump-sum payment, redemption allows you to strip away any part of the loan that is above the car's value. For example, your car is worth $4,000, but the loan remaining on it is $7,000. If you pay the lender $4,000, you get to keep the car and don't have to pay the lender anything else.
Of course, you assume most people in bankruptcy do not have large sums of cash lying around for a redemption. However, with permission from the court/trustee, you might be able to cash in exempt 401(k) funds for the purpose of redemption, for example. There are also firms that specialize in providing loans specifically to help a bankruptcy filer execute a redemption. But these firms usually charge a high interest rate, so you'll have to determine if it is worth taking on a loan with them.
Bottom LineIf you truly want to wipe out debt and get a fresh start with Chapter 7, then consider surrendering the vehicle or doing a redemption. If you surrender the car, you get to discharge all of the debt you owed to the lender. With redemption, you don't get to wipe out all the car loan, but you can possibly wipe out a significant portion of it, and you get to keep the car as well. However, if you're satisfied with just continuing with the same arrangement you previously had with the lender, reaffirmation gives you that option.