How to File for Bankruptcy and Keep Your Car

Filing for bankruptcy is scary stuff, and scarier still if hanging onto your car is among your chief concerns. All that talk about “liquidation” is enough to put anyone on edge.

Does it help to know you’re not worrying alone? According to a landmark study, people filing for bankruptcy are more concerned about keeping their car than they are about keeping most anything else, including their house. Small wonder: For most people — even those not in financial straights — access to a car is a lifeline.

The good news: The system is set up to allow people to keep their car after filing for bankruptcy. Some even file for bankruptcy as a means of keeping their car.

A 2019 Consumer Bankruptcy Project report found that many consumers in deep debt will default on their mortgage before they put their car at risk. For them, using bankruptcy exemptions that protect their car is the better option. This holds true even for filers of Chapter 7 (also known as straight, or liquidation) bankruptcy. Once you get past the worrisome terminology, you learn Chapter 7 is the most popular for individuals who, having few assets, keep most of what they own, including their car.

“Based on our research, some of the people who file bankruptcy do so with the main goal of keeping their car,” said Pamela Foohey, a University of Georgia law professor and an author of the CBP study. “Bankruptcy includes ways for them to keep their car while discharging other debt. It makes filing bankruptcy potentially productive.”

Chapter 7 offers two options for keeping your car: a reaffirmation agreement (you recommit to the loan after modifications agreed to by the lender); or a redemption (you buy the car outright, typically at its current value).

Chapter 13 allows bankrupts to continue to pay their car loan and other debt under a structured plan.

These are mere synopses, of course. In both chapters, getting to the point where you are able to secure your car requires clearing several hurdles.

Bankruptcy and Its Impact on Assets

Bankruptcy, while punishing, is not designed to be ruinous. In fact, its purpose is to give those hopelessly in debt a fresh start, with soft tools to help them avoid future financial catastrophes.

Among the ways bankruptcy law softens the blow is through somewhat generous allowances for protecting personal items, or assets, including cars.

“Bankruptcy can place certain assets at risk,” says Emma Davidson, a finance advisor and high-risk payment consultant with Miami-based eMerchant Authority. “Your car is considered an asset. Its value is determined by its market value minus any outstanding loan balance. If the remaining equity is within your state’s exemption limit, it’s protected in bankruptcy.”

There it is: Your first hurdle. Individual debtors must file a schedule of exempt property. Know what you’re getting into. The Bankruptcy Code provides for exemptions described by federal law but also allows states to adopt their own list of exemptions. To further complicate matters, some states allow debtors to choose between federal and state exemptions.

Generally, however, exempt property includes:

• Your principal residence.
• Personal everyday items.
• Household goods (furniture, housewares, appliances).
• Health aids.
• Retirement accounts, pensions, 401(k) plans.
• Life insurance policies.
• Tools of the trade for small businesses and self-employed individuals.
• Your main vehicle.

Again, the purpose of bankruptcy is to relieve otherwise unmanageable debt. And, historically, more than 90% of individuals filing under Chapter 7 are able to keep all they own. Occasionally, however, liquidation bites deep.

Nonexempt assets include:

• Second homes.
• Investments outside your retirement accounts.
• Luxury items.
• High-priced collectibles.
• Expensive clothing and jewelry.
• Expensive vehicle(s) not covered by exemptions.

For car owners with loans in arrears, filing for bankruptcy is an effective way to stave off repossession. A Chapter 7 filing triggers an automatic stay, preventing creditors — including your car lender — from pursuing collections efforts. Indeed, by filing for bankruptcy, you may be able to reclaim a car that has been recently repossessed.

Additional complications can arise. Your lender, citing inadequate protection of its interests, may request a stay to allow repossession, but you may oppose this motion through legal channels.

All the while, it’s a good idea to attempt to informally negotiate an accommodation with your lender. We’ll dive deeper below.

Similarly, Chapter 13 filers avoid repossession via the automatic stay, followed by a court-approved repayment plan. While you and your lender wait out the process, you must make “adequate protection payments” — usually equal to your pre-bankruptcy payments — or risk repossession.

How to Keep Your Car in Chapter 7 Bankruptcy

OK, having studied your options, you’ve chosen Chapter 7 for a variety of logical reasons. But you’re still bracing for the worst. Let’s go through the methods available for keeping your car, and the steps you must take.

State and Federal Exemptions

Know this: In most cases, state and federal exemptions will help protect your car from the clutches of the bankruptcy trustee.

You’ll have to know whether there’s equity in your car (more about that in a moment), and if so, how much. Because lawful exemptions keep the trustee and creditors at bay. Federal bankruptcy law allows individuals to protect up to $4,450 in vehicle equity; for married couples, under the right circumstances, the exemption is $8,900.

But wait: States may be more generous. Florida recently upped its vehicle exemption to $5,000. Virginia allows $6,000. Oklahoma protects vehicle equity up to $7,500.

We mentioned those exemptions doubling if you’re married and filing jointly. The caveat: Both names must be on the car’s title.

Keep in mind, also, exemptions for personal property, typically $1,000 for individuals, and the “wild card” — $1,475 for those using federal guidelines; some states offer substantially more — you may want to consider applying to your car’s equity. (Pro tip: Most trustees don’t want your used furniture, appliances, or clothes, which potentially frees up the personal and wild card exemptions.)

In short, it’s vital you know the state of your state’s bankruptcy exemptions, and how you can make them work for you.

Equity in Your Vehicle

When it comes to vehicles, equity plays a key role. That is, the fair market value of your car minus the balance (if any) of your loan. Suppose your car is worth $15,000, but you owe $20,000. The bad news is you’re upside down by $5,000. The good news is the bankruptcy trustee won’t pursue your car to help repay your creditors.

If your car has equity — swap that last scenario; it’s worth $20,000, and you owe $15,000 — those exemptions come into play. Only $5,000 in equity? Under virtually any scenario, you’re keeping the car. Yes, even when applying the federal exemption, for assorted and rather complex reasons.

The trustee has to figure the car’s fair market value at a quick sale (to a dealership, or companies such as CarMax), which — because the dealer/car-seller wants to flip it for a profit — would be substantially less than the fair market value upon which your equity is based. Other considerations include the lien payoff, costs of the sale, and the trustee’s cut. Factor in the exemption for equity (at least $4,450), which has to be paid to you, and most likely the trustee would report the car has “inconsequential value.”

A vehicle with plenty of equity is a different story. However, exactly how much equity your car must have to interest the trustee is murky, at best. But beyond a certain threshold, the higher the equity (you have a lien-free, spotless vintage Bentley, for instance), the more likely the car will be targeted for liquidation.

Even the extra-equity aspect has a wrinkle.

“Trustees always believe that the best market for your car is you,” says bankruptcy judge Catherine Peek McEwen, who’s served on the federal bench in Tampa for 19 years. “So you would negotiate with the trustee about a payback. The trustee would say you’ve got $2,000 of equity in your car above your loan amount and above your $5,000 exemption allowance. You want to keep the car? Sure I do. How quickly could you pay that $2,000 to me? That’s a way it can be done.”

Reaffirmation Agreement

If you’re a Chapter 7 filer with an outstanding vehicle loan, a reaffirmation agreement may be your best bet for keeping your car. A reaffirmation agreement is not simply a legal commitment to keep making punctual payments on your existing loan. Instead, you’ll wind up with a new agreement involving a strict payment plan.

Your reaffirmation plan may have the same terms as your prior loan, but your fresh commitment blocks repossession activities as long as your payments are timely. Additionally, negotiations between you and your lender regarding the size of your payments, interest rate, and length of the loan are possible. As a piece of your bankruptcy case, the court must approve your reaffirmation agreement.

Reaffirming your car loan is a key moment in your bankruptcy proceeding. Your recommitment keeps you on the hook for paying whatever terms wind up in your new loan. Not only will your car be subject to repossession if you fall behind, but you will be liable for any shortfall in your loan balance after the car is resold.

Redeeming Your Car

Redeeming your car involves making a single, lump-sum payment to the lender for the vehicle’s current fair market value. This may be a worthwhile option if the car is worth significantly less than the loan balance: The loan goes away, and you keep your car, free and clear.

We hear you: If you had a spare $6,000 stashed in a money market account, you wouldn’t be filing for bankruptcy. However, you should not rule out the sympathetic generosity of a benevolent uncle.

If family assistance is a nonstarter, explore your loan options. There are, in fact, lenders who specialize in bankruptcy redemption financing. Expect the interest rate to be steep, but if the loan amount is small compared to your car loan balance, the payment schedule may make sense.

How to Keep Your Car in Chapter 13 Bankruptcy

OK, so you have studied your options and concluded, of all the solutions available, Chapter 13 bankruptcy is your most logical choice.

“Chapter 13 bankruptcy offers a bit more leeway,” says New Jersey-based Michael Schmied, founder and senior financial analyst at Kredite Schweiz. “If you’re current on your car payments, or you include your car loan in your repayment plan, you can generally keep the vehicle. This type of bankruptcy lets you propose a plan to manage your debts over a few years.”

The key here is that your repayment plan should cover the value of the car. The court will look at your plan and financial situation to ensure you’re making reasonable efforts to pay your debts. It’s a more flexible option if you want to keep your car while managing your financial obligations.

Here is what you can expect when it comes to hanging onto your car.

Repayment Plan

Chapter 13, or wage-earner’s bankruptcy, is designed to cure financial disaster by reorganizing your debts into a more manageable package. If your car loan goes into your bankruptcy pot, the outstanding balance is subject to the same restructuring as the rest of your bankruptcy-eligible debt.

Working with your creditors, the bankruptcy trustee’s job is to create a plan that makes your debt load, including your car loan, affordable. Then, at the end of three-to-five years, whatever balances remain — assuming you stuck to the plan — are discharged by the court.

Car Loan Cramdown

If you’re upside down on your car loan, Chapter 13 provides a certain amount of leverage for reducing both the balance and interest rate. The process is typically known as a “cramdown” — you’re cramming unpleasant financial terms down the creditor’s throat — although, in her courtroom, Judge McEwen prefers “strip down,” leaving “cramdown” for business bankruptcies.

Whatever it’s called, the result is the lender accepting a revised loan with a lower balance and, perhaps, a lower interest rate. What’s in it for the lender? Borrowers who are significantly upside down on their loans — that is, the balance is substantially higher than the value of the car — have an incentive to surrender the car and walk away, and let their bankruptcy deal with the shortfall.

Consider this scenario: You took out a $30,000 loan to buy a new car. A few years later, the car has depreciated to $10,000, but the stubborn loan balance is $20,000. Only $10,000 of the loan is secured (if even that much, given the vagaries of quick sales), because if the car were repossessed, the lender would, at best, squeeze $10,000 out of a car it doesn’t want back in the first place.

You propose a new loan in which you pay only the fair market replacement value: $10,000. If accepted, you will have crammed down your loan by $10,000.

Bonus: Bankruptcy law allows you to lower your interest rate, usually prime plus two or three points.

As for the unpaid portion of your loan, that $10,000 you got stripped off — because you don’t want the IRS declaring the forgiven amount is income — goes into your bankruptcy pot, where it will be treated with relative indifference, just like the rest of your nonpriority unsecured debts. At the end of your payment plan, any unpaid balances will be wiped out.

Because there’s always a caveat, here’s the cramdown rule-of-the-road: To prevent consumers from buying new cars and attempting to cram down their loans soon after, to qualify, at least 910 days must have elapsed since you purchased your car.

Additional limitations: You cannot cram down a loan for a business vehicle (sorry, ride-share side-giggers), or for one that is driven by someone other than the bankruptcy filer.

Automatic Stay Protection

Your car will be covered by the automatic stay that opens as soon as you file for bankruptcy. Under that legal umbrella, bill collectors must cease all collection activities. Moreover, your car will be protected, at least temporarily, from being repossessed.

The automatic stay remains in place throughout your bankruptcy proceedings, including the point, in Chapter 13, when your reorganization is approved and your repayment program begins.

You may not be completely in the clear, however. Your car’s note holder may object to his/her end of the bargain, and may even ask for the stay to be lifted so an attempt at repossession can resume. You may be obliged to demonstrate that you have reasonable car-related expenses.

If your car has substantial equity, and you intend to keep it, you also may have to roll an amount equal to your car’s nonexempt equity into your payment plan. Yes, you have to buy your car all over again. Otherwise, the $25,000 of equity in your paid-off luxury SUV would have been liquidated to pay creditors, even in Chapter 13.

Remember, the stay remains in place only while your payments are current.

Keeping the Car Outside of Bankruptcy

The 2005 Bankruptcy Abuse Prevention and Consumer Protection Act eliminated “drive through” car loan agreements for bankruptcies. Before the act, consumers and car lenders could continue with whatever agreement they wanted, ignoring the bankruptcy. While drive-throughs are now against bankruptcy rules, it still happens and courts rarely enforce it.

When no intention to reaffirm, redeem or surrender the car is filed by the deadline, a car loan is dropped from the bankruptcy. In many cases, the car owner and lender continue to do business as before, and courts rarely intervene. Of course, this only works for the car owner if they are making timely payments.

Since this option is counter to bankruptcy law, it’s not necessarily something you want to pursue; it provides far less protection than going with one of the routes allowed by law.

If you’re thinking of going this route, be super careful. “The lender has some special rights,” Judge McEwen says, “and you need to know which ones are OK [with drive-through situations] and which aren’t. Some will come pop your car if you don’t reaffirm, even if you’ve never been late on a payment.”

Assessing the Value of Keeping the Car

We’ve discussed how to keep your car in bankruptcy. But should you? And how do you decide?

“Every situation is unique and needs a thorough examination of the individual’s financial circumstance,” says Sheridan, Wyo.-based Jonathan Feniak, general counsel and head of finance at LLC Attorney. “Remember, it’s not always about what you can do, but also about what you should do, taking into consideration a comprehensive financial strategy.”

Factors to evaluate include the value of the car, how affordable it is to operate, how burdensome even a reworked loan would be, the remaining length of the loan (if you reaffirm), and, if you decide to surrender it, whether the lender is inclined to take the car back.

You will want to consider whether there are more affordable transportation options available. Is public transportation feasible for most of your getting-around needs? Do you live within a reasonable bicycle ride from your key destinations, such as work, school, or shopping? Are you attempting to hold onto a luxury vehicle when something less expensive would do the trick?

Only when you have satisfied these questions will you know whether it’s wise to keep the car you have, or seek alternatives.

“Overall,” finance advisor Davidson says, “the decision to keep or surrender your car during bankruptcy depends on your financial circumstances, the car’s value, and how crucial the vehicle is to your daily life. Consulting a bankruptcy expert can help you navigate these decisions effectively.”

Speaking of which …

Navigating Bankruptcy to Keep Your Car

The bankruptcy code offers abundant opportunity for most car owners who want to keep their ride to do just that. Whether it’s redeeming or reaffirming, cramming down or going the stealthy (and inadvisable) drive-through route, when it comes to holding onto Old Blue, you have options.

It’s best not to attempt to navigate these choppy waters alone, however. If you’re committed to declaring bankruptcy, or merely teetering on the precipice, strongly consider consulting a bankruptcy attorney before you get too deep.

“Careful analysis is required to make the best decision,” says Wyoming Trust founder and CEO Mark Pierce. As a bankruptcy attorney, “My role involves not only navigating the intricate regulations and laws but also evaluating my client’s financial landscape to ensure they are shielded from unnecessary cost and exposure.”

Just getting your feet wet on whether bankruptcy is right for you? Seek guidance from a nonprofit credit counseling agency. There’s no charge and no obligation, and you may discover you can keep your car while avoiding the long-lasting devastation to your credit report bankruptcy wreaks.