How Auto Loan Interest Accrues During Chapter 13 Bankruptcy

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How Auto Loan Interest Accrues During Chapter 13 Bankruptcy

Filing for Chapter 13 bankruptcy can provide much-needed relief if you’re struggling with overwhelming debt, but it doesn’t make your auto loan payments disappear. When you file Chapter 13, you get to keep your assets like your home and car, but you have to commit to a 3-5 year repayment plan to pay back a portion of your debt. This means you’ll need to continue making payments on any auto loans you have – and interest will continue accruing on those loans during your bankruptcy.

We’ll walk through how auto loan interest works during and after Chapter 13 bankruptcy so you know what to expect. This process can be confusing, but having a clear understanding will help you make the best choices for your situation.

Auto Loans Are Treated Differently Than Other Debts

Most of your unsecured debts like credit cards, medical bills, and personal loans can be partially or fully discharged through Chapter 13 bankruptcy. This means you may only have to pay back a percentage of what you owe on those debts (as little as 0-20%).

But auto loans are treated differently in bankruptcy because they are secured debts – your car serves as collateral on the loan. This gives the lender more power to get repaid. So even if you file Chapter 13 bankruptcy, you’ll still be on the hook for 100% of your remaining auto loan balance, plus all interest and fees.

The bankruptcy court can’t change the terms of your auto loan or reduce the amount you owe. The lender gets to keep their full claim against both you and the vehicle.

Some key points about auto loans in Chapter 13 bankruptcy:

  • You must keep making your regular monthly payments according to the original loan terms.
  • Any missed payments or interest that accrued before filing will be added to your total balance.
  • Interest keeps accruing at the original rate during and after bankruptcy.
  • The lender can repossess your vehicle if you default on payments.

So while Chapter 13 pauses collections and foreclosure against you personally, it doesn’t affect the lender’s rights regarding the car itself. You get to keep driving it only if you stay current on the loan.

Your Loan Terms Stay the Same

When you file for Chapter 13 bankruptcy, the court approves a repayment plan that dictates how much you’ll pay toward your debts over the next few years. But this repayment plan does NOT change the terms of your auto loan in any way.

For example, let’s say you have:

  • A 5-year auto loan
  • 3 years left on the term
  • A 10% interest rate
  • $15,000 remaining balance
  • $350 monthly payment

If you file Chapter 13 bankruptcy, you’ll still have 3 years left to pay, the 10% interest rate stays the same, and your regular monthly payment remains $350. The bankruptcy court cannot lower your interest rate, reduce your payment, or change the loan length.

The only impact is that any missed payments before filing get added to your total balance. So if you were 2 months behind when you filed, that $700 would be tacked onto your remaining $15,000 principal.

Interest Keeps Accruing

One major disadvantage of keeping your car in Chapter 13 is that interest continues to accrue on the loan throughout your 3-5 year repayment plan.

For example, let’s say your car loan has a balance of $15,000 at a 10% interest rate when you file Chapter 13. Over the next 5 years of your repayment plan, another $7,500 in interest will accrue on that principal balance. So by the time you complete your bankruptcy, you’ll owe $22,500 on that loan!

This increasing debt can make it difficult to successfully complete Chapter 13 and get a discharge. The accruing interest drives up your total repayment amount.

Unfortunately there’s no way to stop interest from accruing on a secured auto loan in bankruptcy. Even if you file the very next day after taking out the loan, interest keeps accumulating according to the original loan agreement.

That’s why it’s usually better to have an older car that you own free and clear when you file for bankruptcy. No interest accruing means your total repayment amount stays lower.

Prioritize Paying Down Auto Loans

Since you can’t escape auto loan payments and interest in Chapter 13, it’s wise to prioritize paying down your car loan early in your plan.

Work with your attorney to create a repayment plan that puts extra money toward the auto loan upfront. This will limit how much interest can accrue over the 3-5 years.

For example, let’s say you have:

  • $15,000 auto loan at 10% interest
  • 60 month Chapter 13 plan
  • $500 monthly disposable income

If you put an extra $200 each month toward the principal balance for the first 2 years, you could knock it down to about $10,000. That really minimizes the interest that will accrue in years 3-5 of your plan.

Every extra dollar you pay toward principal early on reduces the base that interest accrues on. This will help you complete Chapter 13 with less debt – and lower ongoing payments when you emerge from bankruptcy.

Consider Refinancing After Bankruptcy

The good news is that you may be able to refinance your auto loan once your Chapter 13 bankruptcy is discharged. This can help you get better terms and lower interest.

It’s tough to refinance while you’re still in bankruptcy since your credit is damaged and you have limited income. But after you receive a discharge, your credit score starts recovering and you can qualify for better rates.

Most experts recommend waiting at least a year after your Chapter 13 discharge to refinance. This allows some time for negative information to fall off your credit reports and for your score to start improving.

To get the best refinance rates, you’ll want a credit score over 640 and steady income. Having a good payment history on your auto loan during bankruptcy will also help.

When refinancing after bankruptcy, aim for an interest rate at least 2-3% lower than your current rate. This will make the refinance worth it by reducing your ongoing interest costs and payments.

You can shop around online at places like Lightstream, PenFed, and local credit unions to find the best refinance offer. It takes a little time and effort, but can really pay off through thousands in interest savings.

Surrendering Your Car in Chapter 13

If your auto loan payment plus insurance is too much to handle during bankruptcy, you do have the option to surrender your car.

Surrendering the vehicle returns it to the lender, who then sells it at auction. Any remaining loan balance after the sale is considered unsecured debt that can be discharged through your Chapter 13 bankruptcy.

However, there are a few downsides to be aware of with surrendering your vehicle in Chapter 13:

  • The lender can sue you for any loan deficiency not covered by the sale proceeds.
  • It damages your credit worse than keeping the loan.
  • You’re left without a vehicle – unless you can afford to buy another used car.

If you’re underwater on your auto loan (you owe more than it’s worth), surrender may be your best option to escape the debt. But if you have equity in the vehicle, keeping it and continuing payments is usually better for your situation.

Getting a New Car Loan After Bankruptcy

Many people need to replace their vehicle after filing for bankruptcy. But having recent bankruptcy makes getting approved for an auto loan very challenging.

Most mainstream lenders will automatically deny your application if you filed for bankruptcy within the past 1-2 years. So trying to get a car loan while you’re still in Chapter 13 is pretty much impossible.

Your best options are to buy a used car in cash, or wait until at least 12 months after your Chapter 13 discharge to apply for financing. Waiting longer – like 2-3 years – will open up better rates and lender options.

To improve your chances of getting approved, you’ll need:

  • Down payment of at least 10-20%
  • Proof of steady income for 1-2 years
  • Higher credit score – aim for at least 640
  • Low debt-to-income ratio – under 30% is best

Expect much higher interest rates than normal – possibly over 10% even for buyers with good credit. Lenders view you as high-risk so you get stuck with subprime financing offers.

If you have an urgent need for a car, consider financing through a “buy here, pay here” used car lot. They’re more likely to approve bad credit buyers, but the terms are rarely favorable.

The Impact on Your Credit Score

Filing for Chapter 13 bankruptcy causes a significant hit to your credit scores, typically in the range of 130-160 points. The bankruptcy will stay on your credit reports for 7-10 years.

However, making consistent on-time payments on your auto loan before, during, and after bankruptcy can offset some of that damage. It shows lenders you’re committed to repaying your debts.

You may also see your scores start to gradually improve in the 2-3 years after your Chapter 13 discharge as negative information falls off your reports. Removing late payments, defaults, and other derogatory marks helps boost your credit back up.

A good strategy is to check your credit reports annually and dispute any errors you find that may be dragging your scores down. This can help speed up the process of rebuilding credit after bankruptcy.

Having a higher credit score will open up better options if you need to replace your vehicle or refinance the loan. So take steps to monitor and improve your credit as much as possible after filing.

Consult an Attorney About Your Situation

Every person’s financial situation is unique, so it’s important to speak with an experienced bankruptcy attorney before deciding if Chapter 13 is your best option.

An attorney can review your full financial picture – including assets, debts, income, and expenses – and then explain how your auto loan and interest would be handled in bankruptcy. They can also advise you on other debt relief options that may be better suited for your needs.

Navigating the bankruptcy process on your own is very difficult and can result in mistakes that hurt your case. Let a knowledgeable attorney protect your rights through each step of Chapter 13.

If you’re struggling with debt, don’t wait – consult an attorney today to discuss your bankruptcy options. The sooner you act, the sooner you can work toward becoming debt-free with a fresh financial start.

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