What Happens to Your Car Loan in Bankruptcy?

Filing for bankruptcy can be a difficult decision, often driven by overwhelming debt. However, it can also provide a path to financial relief. If you’re facing bankruptcy and have an active car loan, you may be wondering how it will affect your vehicle and loan obligations. Understanding the implications of bankruptcy on your car loan is essential to making informed decisions about your financial future. In this blog, we will explore what happens to your car loan in bankruptcy, the different types of bankruptcy, and the options you have for managing your car loan.

Types of Bankruptcy and How They Affect Your Car Loan

There are two common types of bankruptcy that individuals file for—Chapter 7 and Chapter 13. Both types can affect your car loan, but in different ways.

Chapter 7 Bankruptcy

Chapter 7 bankruptcy is often referred to as “liquidation bankruptcy.” In this type of bankruptcy, your non-exempt assets are sold to repay creditors. However, exemptions exist that may allow you to keep certain assets, including your car.

• If You Have Equity in Your Car: If your car has a significant amount of equity (meaning the value of the car exceeds the loan balance), the bankruptcy trustee may sell your car to pay off creditors. However, some states have exemptions that may allow you to keep your car even if it has equity.
• If You Don’t Have Equity in Your Car: If your car doesn’t have much equity, you may be able to keep it, especially if the car is essential for your daily life and work.
• Secured vs. Unsecured Loan: Your car loan is secured by the vehicle, meaning the lender can repossess the car if you default on the loan. In a Chapter 7 case, if you continue to make payments on the car loan, you can usually keep your car. However, if you fall behind on payments, the lender can repossess the car.

Chapter 13 Bankruptcy

Chapter 13 bankruptcy is a form of reorganization bankruptcy. Instead of liquidating your assets, you work out a repayment plan with your creditors, usually lasting three to five years.

• Car Loan in Chapter 13: If you have a car loan, you may be able to reduce the amount you owe on the car loan through a process called “cramdown.” This allows you to pay off the loan for the current market value of the car, instead of the amount remaining on the loan.
• Keeping Your Car: Since Chapter 13 involves a repayment plan, if you continue making payments according to the plan, you can typically keep your car. However, if you fail to make the required payments, the lender can still repossess the vehicle.

What Happens to Your Car Loan If You Choose to Surrender the Vehicle?

In some cases, people filing for bankruptcy choose to surrender their car. This may happen for several reasons, including if the car is too expensive to maintain, the monthly payments are unaffordable, or it’s simply no longer a necessity.

• Surrendering the Car in Chapter 7: If you surrender your car in Chapter 7 bankruptcy, the lender will sell the vehicle to recover the remaining balance of the loan. Any deficiency (the difference between the sale price and the amount you owe) may be discharged in bankruptcy, depending on the state laws.
• Surrendering the Car in Chapter 13: If you surrender your car in Chapter 13 bankruptcy, the same process applies. However, the deficiency may still be treated as an unsecured debt and included in your repayment plan.

How Does Bankruptcy Affect Your Car Loan Payments?

Even if your car loan is not discharged in bankruptcy, it’s important to understand how bankruptcy will impact your payments and the terms of your loan.

Chapter 7 Bankruptcy

• No Automatic Reduction in Loan Payments: In Chapter 7 bankruptcy, your loan payments will generally remain the same. However, you may be able to discharge other unsecured debts (like credit card debt) to free up money to make your car loan payments.

Chapter 13 Bankruptcy

• Reduced Payments: Under a Chapter 13 repayment plan, you may have the opportunity to reduce your car loan payments, especially if your car’s value is less than what you owe on the loan. This can provide significant relief, particularly for those with high car payments.
• Interest Rates: In Chapter 13 bankruptcy, your loan’s interest rate may also be reduced, which can help lower your monthly payments.

Should You Keep or Surrender Your Car?

Deciding whether to keep or surrender your car during bankruptcy depends on several factors. Here’s a breakdown of considerations:

• Affordability: Can you afford the monthly car payments after filing for bankruptcy?
• Vehicle’s Value: Is your car worth more than the loan balance? If so, it might be worth keeping.
• Vehicle’s Condition: Is your car reliable enough to continue driving, or is it costing you a lot in repairs?

Pros and Cons of Keeping Your Car

Pros:

• You can keep your vehicle if you continue to make payments.
• You retain transportation for work, school, and other essential activities.
• The option of a Chapter 13 “cramdown” may reduce your loan balance.

Cons:

• You may need to keep up with high payments and interest rates.
• If the car is not essential, keeping it may add unnecessary financial strain.

Pros and Cons of Surrendering Your Car

Pros:

• You can eliminate an unaffordable car loan from your financial obligations.
• It may provide relief if you’re struggling to make car payments.

Cons:

• You may lose transportation.
• Surrendering the vehicle may still result in a deficiency balance, which could be discharged in Chapter 13 but not in Chapter 7.

How Bankruptcy Affects Your Credit

Filing for bankruptcy will have an impact on your credit score, and this includes your car loan. However, the effect of bankruptcy on your credit score may not be as severe as you think.

• Short-Term Impact: Bankruptcy will cause a significant drop in your credit score initially, but it also wipes out a lot of other debt, allowing you to rebuild your credit over time.
• Long-Term Impact: As you begin to rebuild your credit after bankruptcy, your car loan payments will be a crucial part of that process. Making timely payments on your car loan after bankruptcy can help improve your credit score in the long run.

Table: Bankruptcy Options and Impact on Your Car Loan

Conclusion

Navigating the complexities of bankruptcy can be overwhelming, especially when it comes to handling your car loan. The choice between keeping or surrendering your vehicle largely depends on your specific financial situation, the type of bankruptcy you file for, and your ability to continue making payments. Whether you file for Chapter 7 or Chapter 13 bankruptcy, it’s important to understand how each option impacts your car loan and what steps you can take to protect your financial future.

While bankruptcy can provide the opportunity to eliminate overwhelming debt, it’s crucial to consult with an experienced bankruptcy attorney to ensure you’re making the best choice. Padgett & Robertson is here to help guide you through this challenging process, offering expert legal advice and support tailored to your needs. If you have questions about how bankruptcy might affect your car loan or if you’re ready to take the next step, don’t hesitate to contact us today.

Padgett & Robertson
Phone: (251) 336-3695