Bankruptcy offers relief but carries a burden: You’ll have to restructure your finances and potentially agree to pay back some of your debts. You might even have to part with important property like your vehicle.
For many people, a personal vehicle is an essential lifeline. Thankfully, there is a good chance you’ll be able to keep your car if you file bankruptcy. But your car’s value will affect which bankruptcy type is best to pursue and you may have to take extra steps to protect your vehicle.
What happens to your car in Chapter 7 bankruptcy
A Chapter 7 bankruptcy is known as liquidation bankruptcy. When you file this type of bankruptcy, you are typically required to:
- Sell assets to repay your debts.
- List your assets, including your car.
- File an exemption if you want to keep your car.
Most states offer an exemption for motor vehicles, meaning you can exempt your car from bankruptcy and maintain ownership. However, this is determined through a formula that considers the car’s equity and your loan status.
To figure out how much equity you have in your car, take your loan balance and subtract it from the value of your car. After you know how much equity you have, find the motor vehicle exemption in your state. If you have less equity than the exemption limit, you shouldn’t have any issues keeping your car.
What happens to your car in Chapter 13 bankruptcy
Chapter 13 bankruptcy is known as a reorganization bankruptcy. Instead of paying back your debts by liquidating your assets, you agree to:
- Sign up for a repayment plan.
- Repay a portion of your debts over three to five years.
Chapter 13 bankruptcy does not require you to liquidate your car, and you likely will be able to hold onto it through the proceedings.
What happens to your auto loan if you file for bankruptcy
The lender may repossess your car if you file for Chapter 7 and aren’t in good standing with your auto loan. Your vehicle won’t be protected by any exemptions if you haven’t kept up with your loan payments.
There are two ways you may be able to keep your car:
- Paying the remaining balance in one lump sum. If you pay off the balance of the loan, the debt is resolved and you don’t need to make good on it by handing over the vehicle.
- Signing a reaffirmation agreement. If you sign this type of agreement, you are committing to making monthly car payments as if you hadn’t filed bankruptcy. If you change your mind, you can rescind or cancel a reaffirmation agreement within 60 days or before the court gets involved. You will need to return the car in this case.
When it comes to Chapter 13 bankruptcy and your car loan, it’s also important to know that the amount you owe on it may be reduced, especially if you owe more than it’s worth.
How to protect your car in bankruptcy
The best way to protect your car in bankruptcy, regardless of the type of bankruptcy you choose, is to own it outright. If you are able to, you can redeem your car loan by paying your lender the car’s current fair market value.
Unfortunately, this may not be possible for many people facing bankruptcy, so you may want to consider reaffirming your loan or having it exempted from Chapter 7.
Reaffirming your auto loan
A reaffirmation agreement allows you to modify the terms of your loan to make repayment easier during and after Chapter 7 bankruptcy. A car loan will allow you to keep your vehicle as long as you make payments according to the terms in the reaffirmation agreement.
You will need to file the agreement with the bankruptcy court within 60 days of your first meeting with your creditors.
While reaffirmation allows you to keep assets like your car out of bankruptcy proceedings, it may not always be the right choice. If you struggle to keep up with payments, you may want to consider buying a less expensive car or requesting an exemption.
Bankruptcy exemptions
An exemption shields your vehicle during bankruptcy. The federal exemption limit for vehicles is currently $4,450 — a figure that will remain in place until 2025. Some states also offer generous exemptions and allow you to combine exemptions, but others may have a lower exemption amount.
You may also be able to use the wildcard exemption rule if your car is worth more than the exemption limit imposed by your state.
Exemptions are not based on the amount you paid for your vehicle. Instead, they are based on its actual cash value. Factors like your car’s year, make and mileage, as well as your current loan, will impact how your car’s actual cash value is determined. Sources like Kelley Blue Book or Edmunds may also be used to determine value.
As long as the value of your car is under the exemption amount, you can claim the exemption and keep your car. If it is valued at more than the exemption limit, the bankruptcy trustee may choose to sell your car to pay your creditors. For example, you would be able to keep a car valued at $3,500 if your state uses federal exemption rules. However, a car valued at $5,000 would likely need to be sold to pay back your debts.
The bottom line
Before you move forward with Chapter 7 or Chapter 13 bankruptcy, make sure you understand exactly how it will affect your car. Take steps to pay off your vehicle if at all possible. This gives you the best chance of keeping it.
Also, research any exemptions available in your state so you and your attorney can file an informed bankruptcy petition that specifically asks you to be allowed to keep your car. If you lose your car, you can get a new auto loan after bankruptcy, but you will likely need a co-signer if you require a car immediately.
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