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How Filing for Bankruptcy Impacts Your Auto Loan

Filing for bankruptcy can be super stressful, and one big worry many people have is what will happen to their car and auto loan if they file. Your vehicle may feel like a lifeline—after all, for most folks, having a car is essential to get to work, run errands, and take care of your family. The good news is, there are options in bankruptcy that may allow you to keep your car, even if you still owe money on the loan.

The impact on your auto loan depends on a few key factors:

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  • Whether you file Chapter 7 or Chapter 13 bankruptcy
  • How much equity you have in your vehicle
  • The state you live in and its exemption laws
  • Whether you are current on your loan payments

Let’s break it down step-by-step so you understand how it works.

Chapter 7 Bankruptcy and Auto Loans

Chapter 7 bankruptcy liquidates some of your assets to pay back creditors. With Chapter 7, you typically get to keep most of your property, as long as it falls under your state’s exemption laws. Laws differ by state, but often exempt at least a certain amount of equity in your car—meaning the current value of your vehicle minus what you still owe on the loan.

For example, let’s say your car is worth $15,000 today, but you still owe $12,000 on the loan. That means you have $3,000 in equity. If your state’s exemption protects up to $5,000 in vehicle equity, you may be able to keep the car.

But if you have more equity in your vehicle than your state’s exemption allows, the bankruptcy trustee could force you to sell your car to pay creditors. The trustee may also ask you to voluntarily give up the car if it has significant value.

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So before filing Chapter 7 bankruptcy, take a look at your state’s exemption laws to understand how much vehicle equity you can protect.

Reaffirming Your Auto Loan in Chapter 7

In Chapter 7 bankruptcy, you can also choose to reaffirm your auto loan. This means agreeing to continue making payments on the original terms, even after your other debts are discharged. To do this, you’ll need to get written approval from the lender and file a reaffirmation agreement with the bankruptcy court.

Reaffirming the loan allows you to keep the car, but also sticks you with ongoing payments. So it only makes sense if you’re current on the loan and can continue affording the payments. If you were behind on payments before filing bankruptcy, the lender may not approve the reaffirmation anyway.

Redeeming Your Auto Loan in Chapter 7

A third option is redeeming your auto loan. This means paying off the loan balance as a lump-sum after filing Chapter 7 bankruptcy. To do this, you’ll need to come up with cash, often by borrowing from family or friends. It allows you to keep the vehicle free and clear without any more payments.

Redeeming only makes sense if you have significant equity built up and can get an affordable loan to pay off the balance. Say you owe $12,000 on a car worth $15,000—redeeming could allow you to keep the car for a new $12,000 loan rather than payments of $400 a month.

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Chapter 13 Bankruptcy and Auto Loans

Chapter 13 bankruptcy sets up a 3-5 year repayment plan to catch up on debts. With Chapter 13, you get to keep all your property, including cars. But you have to continue making payments on any loans like normal.

The catch is that your repayment plan only needs to pay back a portion of what you owe on the car—not the full loan balance. This part of the unpaid balance is discharged when you complete Chapter 13.

For example, let’s say you owe $18,000 on your auto loan over 4 years at 6% interest. In Chapter 13, the repayment plan may only require you to pay back $14,000 of that balance. The remaining $4,000 would be discharged at the end of your repayment term.

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Chapter 13 also allows you to catch up on any missed payments. If you were a few months behind before filing, your repayment plan folds the past-due amount into the total balance paid through the plan.

The catch is that you must be current on payments to keep making them as usual. If you file Chapter 13 bankruptcy when you’re behind on your auto loan, the trustee may ask you to surrender the vehicle.

Steps to Take Before Filing Bankruptcy

Before filing for bankruptcy, there are some key steps to take regarding your auto loan:

  1. Review your loan terms – Make sure you understand the total balance, interest rate, monthly payment, and how far along you are in repaying the loan.
  2. Get your vehicle appraised – This will tell you the current market value so you can calculate your remaining equity.
  3. Review exemption laws in your state – This will tell you how much vehicle equity you can protect in Chapter 7 bankruptcy.
  4. Ask your lender about reaffirmation – See if they are willing to let you reaffirm your auto loan in Chapter 7 bankruptcy.
  5. Consider all options – Weigh choices like reaffirming, redeeming, or keeping payments in Chapter 13 to pick the best strategy.

It’s also a good idea to speak with a bankruptcy attorney and financial counselor before making any decisions. They can help assess your full financial situation and walk through how bankruptcy would impact your auto loan and other debts.

The Impact on Your Credit

With both Chapter 7 and Chapter 13 bankruptcy, your auto loan will show up on your credit report as “included in bankruptcy.” This will damage your credit, and the bankruptcy will stay on your report for 7-10 years depending on the chapter you file.

However, you may actually begin rebuilding credit sooner than that since the old auto loan stops counting against your credit utilization once discharged. Continuing to make payments on a reaffirmed loan can also demonstrate you are able to manage credit responsibly.

Alternatives to Discharge in Bankruptcy

For some, bankruptcy may not make sense if the auto loan is their only debt. Here are a few alternatives to discharging your car loan in bankruptcy:

  • Debt management – A debt management plan through a nonprofit credit counseling agency can lower interest rates and consolidate debts into one payment.
  • Debt settlement – Debt settlement companies negotiate with lenders to settle accounts for less than you owe. This leaves you with a lump-sum payment for the reduced settlement amount.
  • Debt consolidation loan – Taking out a new personal loan to pay off the auto loan balance in full can simplify payments with better rates and terms.
  • Voluntary repossession – You may opt to voluntarily surrender the vehicle if you’re significantly underwater on the loan or can’t afford payments.

The right option depends on your financial situation. Talk to a credit counselor or financial advisor to pick the best strategy for handling your auto loan.

The Bottom Line

It is possible to file bankruptcy and keep your car—but it depends on the equity you have, your state laws, and the bankruptcy chapter you file. Chapter 7 allows exemptions to protect equity, reaffirming, or redeeming the loan. Chapter 13 allows you to keep the car while repaying some of the balance. Understanding your options under the bankruptcy code can help you pick the best approach for your situation.

 

Sources:

[1] https://www.bankrate.com/loans/auto-loans/protecting-car-loans-through-bankruptcy/

[2] https://www.bankrate.com/personal-finance/debt/keeping-your-car-in-bankruptcy/

[3] https://www.investopedia.com/how-to-file-bankruptcy-on-a-car-loan-7557611

[4] https://www.experian.com/blogs/ask-experian/what-happens-to-my-car-during-bankruptcy/

[5] https://www.debt.org/bankruptcy/can-i-keep-my-car-if-i-file/

[6] https://www.attorneyfortampabay.com/blog/vehicle-loan-and-working-with-a-debt-settlement-lawyer/amp/

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