Filing for bankruptcy is a serious decision that can damage your credit for seven or 10 years, depending on the type of bankruptcy. But if you’re drowning in debt you can’t pay, it can serve as a last resort to help you hit “reset” on your finances. There are two main types of bankruptcy: Chapter 7, which liquidates some of your assets, and Chapter 13, which focuses on repaying debts. What happens to your car in bankruptcy depends both on the type of bankruptcy you file and how much equity you have in your vehicle.
Can You Keep Your Car After Filing Bankruptcy?
There are several factors that go into whether you’ll be able to keep your vehicle through the bankruptcy process. Since your vehicle is considered an asset, and potentially a valuable one, it’s something creditors may pursue when looking to collect debt. Your vehicle may, however, be counted under an exemption that protects it from repossession. In general, the following is considered to determine if you’ll be able to keep your car:
• The type of bankruptcy you’re filing
• Whether you own, lease or are still financing the vehicle
• The value of the vehicle
• What exemptions apply where you live
How Does Chapter 7 Bankruptcy Work?
Chapter 7 bankruptcy provides financial relief to qualified individuals struggling with debt. Once filed, the automatic stay stops most creditors from contacting you. While in place, those creditors cannot call you, send you bills or letters, or take other action to collect the debt. If you have a car loan when you file for bankruptcy, the creditor cannot repossess the car. On average, you can expect the Chapter 7 process to take three to four months.
Meeting Qualification Requirements
Not everyone is entitled to a Chapter 7 discharge. Your household income can’t exceed the state median income for a family of the same size. If your gross income is less than this amount, qualifying is simple. Otherwise, you’ll have a second opportunity to pass the means test. In that portion, you’re able to subtract necessary expenses including taxes, mandatory payroll deductions, and childcare from your income to see if you pass.
What Happens to Your Car in Chapter 7 Bankruptcy?
Filing for Chapter 7 bankruptcy can clear some unsecured debts, but it may also require selling or giving up some assets to pay debts. The items that is exempt from liquidation, and the value that can be exempted, varies by state. If you file for Chapter 7 bankruptcy and local bankruptcy laws allow you to exempt all of the equity you have in your car, you can keep the vehicle—as long as you’re current on your loan payments. And if the market value of a vehicle you own outright is less than the exemption amount, you’re in the clear. To determine how much equity you have in the vehicle, subtract your current loan balance from the car’s value. Because vehicles tend to depreciate in value fairly quickly, you may not have much equity unless you’re nearing the end of your loan term. Once you’ve determined how much equity you have in your vehicle, take a look at what the motor vehicle exemption is in your state. If you have less equity than the exemption limit, the car is protected.
If the equity in your car exceeds the exemption limit, a few different things can happen.
• The trustee (the person managing your bankruptcy case) can sell your vehicle, give you the exempted amount, and use the remainder to repay creditors. They may also give you the option to pay off the equity at a discount in order to keep the car.
• If you’re behind on your vehicle loan payments, the lender can repossess the car. A vehicle is not protected by the exemption if the loan attached to the vehicle is delinquent. But you may be able to keep the car by paying the remainder of the loan in one lump sum, or by reaffirming the loan, which allows you to modify it and get back in good standing.
• You also have the option to surrender your vehicle to the lender, which removes your responsibility from the auto loan after bankruptcy. But doing so means you won’t have a vehicle and doing so will have credit consequences similar to repossession.
Wiping Out (Discharging) Debt in Chapter 7 Bankruptcy
Many of the debts that plague the average consumer will go away. For instance, you’ll be able to wipe out utility bills; medical debt; personal loans, such as payday loans; and major credit card and department store balances. You won’t be able to get rid of everything, however. You’ll remain responsible for any non-dischargeable debt, such as balances on secured credit accounts commonly used by stores that sell jewelry, electronics, and furniture.
Here are a few other obligations that you’ll remain responsible for:
• income taxes incurred during the prior three years
• domestic support obligations, such as child or spousal support, and
• student loan obligations.
Protecting Property in Chapter 7 Bankruptcy
A person who files a bankruptcy (a debtor) doesn’t lose everything. A debtor can keep (exempt) the property allowed by the debtor’s state. In most cases, it will include:
• some equity in a residential home
• clothing and household belongings
• a modest car (usually determined by the amount of equity in it), and
• an ERISA-qualified retirement account.
You’ll find exempt property listed in your state exemption statutes. Property that isn’t covered by an exemption is called “nonexempt” property. The bankruptcy trustee the official who administers the case will sell the debtor’s nonexempt property and distribute the sales proceeds to creditors.
How to Keep a Financed Car in Chapter 7 Bankruptcy
If you want to keep your car in Chapter 7 bankruptcy and have a car payment, protecting the equity is the first step. You’ll also need to be caught up on the payment and be able to continue making the payment after your case ends. Many people surrender when the car payment is too expensive to maintain.
Pros and Cons of Surrendering Your Car
Whether surrendering your car is a good idea will depend on your particular financial situation. Here are a few points to consider.
The benefits of giving up a car in bankruptcy include:
• You can walk away from it owing nothing, which is beneficial if it’s worth less than you owe or if it needs repair.
• You can reduce your expenses by giving up a costly car payment that you can’t afford.
• You can give up a leased car without having to pay for excess mileage or wear and tear.
Here are some of the downsides to surrendering your vehicle:
• You’ll need to find another mode of transportation.
• If you buy a new car, it might be challenging to get financing, and if you’re able to, your loan will likely come with a very high-interest rate because of the bankruptcy.
• You might end up with a car that isn’t as reliable as the vehicle you turned in.
Process for Surrendering Your Car
You’ll let the court and the lender know of your decision to let go of the car when you complete the bankruptcy form called the Statement of Intention for Individuals Filing under Chapter 7 Bankruptcy. The creditor must obtain permission from the court before repossessing the vehicle by filing a motion asking the judge to lift the automatic stay or getting your agreement to do so. Otherwise, the creditor must wait until the case is over (and the automatic stay is no longer in effect) before repossessing the vehicle. Once the court lifts the stay, the creditor can repossess the vehicle, or you can voluntarily turn the car into the creditor at an agreed location. The creditor will sell the vehicle at auction, but you won’t be responsible for the balance if it doesn’t sell for the amount you owe. The deficiency amount will get wiped out in your bankruptcy case.
Surrendering a Car When You Have a Cosigner
If someone cosigned the loan, the cosigner would remain legally responsible for the deficiency balance the amount remaining after auction but not the entire debt. The cosigner will get credit for the amount the lender receives in the sale (minus allowed expenses). People often wonder how Chapter 7 bankruptcy will affect their ability to keep their car. If you aren’t making payments on a car, then you’ll be able to retain it if its value is below your state’s vehicle exemption amount (the amount of equity you can protect in a vehicle). However, if you are making payments on your car, it’s not so simple. You’ll need to decide whether you want to surrender the car or keep it and continue to make payments and let the bankruptcy court know your decision on an official form called the Statement of Intention for Individuals Filing Under Chapter 7. Similarly, if you’re leasing your car, you’ll indicate whether you will reject or assume the lease on the statement.
Walking Away from the Car
If you want to walk away from the car when you file Chapter 7 bankruptcy, you list the lender on your statement and check the box that indicates you intend to surrender the vehicle that is, hand it back over to the lender. As a result, you won’t be responsible for the car loan after your bankruptcy. If you are leasing your vehicle, you can get out of the lease by checking the “No” box on the statement in response to the question that asks whether you will assume the lease.
Keeping a Car You’re Still Paying For
If you want to keep a car that you are making payments on, your options will depend on whether you’re current on your payments and whether you can pay the current value of your car in a lump sum payment.
• If your payments are current: You can either pay the lender a lump sum to purchase the car at its current value (called redemption) or enter into a new contract (called a reaffirmation agreement), which lets you keep your vehicle under much the terms as your original car’s promissory note (although this is negotiable).
• If your payments aren’t current: You can redeem the car if you have the money to do so. If you don’t, you can try asking the lender to enter into a reaffirmation agreement and to include the missed payments in the new payment arrangement. However, your lender is under no obligation to modify your payment when you’re behind.
Some lenders will allow you to keep the car without doing anything other than staying current on your payment. However, you could lose the car without warning because the lender will be able to repossess the vehicle at any time. You’ll want to talk with an attorney about the pros and cons before selecting this approach. Also, unless you can pay the value of your car in a lump sum payment, you should understand that if you’re behind on your payments when you file, your lender doesn’t have to agree to let you keep the vehicle.
What Happens to Your Car in Chapter 13 Bankruptcy?
Another form of bankruptcy is Chapter 13, which works a bit differently from Chapter 7. Rather than liquidating non-exempt assets to repay creditors, you’ll enter a debt repayment plan. Your property isn’t sold off with this form of bankruptcy; instead, your finances are reorganized and you’ll begin the process of repayment. If you own your car outright you’ll be able to keep it. You will have a repayment period of either three or five years, and once that period ends, some remaining debts can be discharged—meaning you don’t have to pay them anymore. Not all debts can be discharged, however. Credit card and medical debt can be discharged, for example, but mortgages and student loans cannot.
When you file Chapter 13 bankruptcy, your debt is grouped into three buckets:
• Priority debts: These must be repaid in full. This includes bankruptcy costs, unpaid tax bills from the past three years, and child and spousal support.
• Secured debts: Car loans are included in this category. If you have a car loan, the amount you owe on it may be reduced in the Chapter 13 bankruptcy process if you owe more on it than its current value. Also, if you can qualify for a repayment plan and get caught up on your loan, you may be able to keep the vehicle.
• Unsecured debts: These will be discharged in the bankruptcy after you’ve completed your repayment plan.
Keep in mind that if you aren’t able to catch up on your auto loan, or you can’t afford repairs or payments on the car anymore, you can get out of payments by surrendering the car back to the lender, which, as mentioned, has credit consequences.
How Does Bankruptcy Affect Credit?
Both forms of bankruptcy can severely damage your credit for many years to come, so filing isn’t an action that should be taken lightly. Chapter 7 bankruptcy stays on credit reports for 10 years, while Chapter 13 bankruptcy sticks around for seven years. This means even nearly a decade after filing, potential creditors, lenders, landlords, utility companies and others legally allowed to view your credit will be able to see the bankruptcy on your report. Having bankruptcy in your history can cause you to be denied for new applications, such as for loans or credit cards. If a lender or creditor does approve you, you may face sky-high interest rates or fees. During this time, though, you can help rebuild your credit by making wise financial decisions. If you pay all of your bills on time, avoid overspending, and use a secured credit card responsibly, you can slowly nudge your credit score back up.
Automobiles and Bankruptcy Lawyer
When you need legal help with an automobile and bankruptcy in Utah, please call Ascent Law for your free consultation (801) 676-5506. We want to help you!
8833 S. Redwood Road, Suite C
West Jordan, Utah
84088 United States
Telephone: (801) 676-5506
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