Chapter 7 bankruptcy involves a debtor liquidating assets for debt discharge, hence, why it’s sometimes referred to as liquidation bankruptcy. This kind of bankruptcy usually impacts individuals and businesses, who turn to it when they cannot repay their debts.
Generally, Chapter 7 bankruptcy can mean a fresh start for debtors; however, it can mean losing significant assets or a large decrease in wealth. A few implications of bankruptcy proceedings include a huge drop in credit scores, the bankruptcy becoming public record, and collection activities being halted.
If you are going through Chapter 7 bankruptcy and have a car loan (secured debt), you will have the option to continue repaying; if you cannot, the lender can repossess your vehicle. This is pretty similar to how a standard car loan works. However, there may be options to bring your car loan into good standing, which will mean keeping the vehicle.
How Chapter 7 Affects Secured Debts
Secured debt is any debt that includes a collateral asset, while unsecured debt does not have assets involved with the loan.
In Chapter 7, unsecured debts are discharged (exceptions include student loans, alimony, child support, and court fines or penalties). However, a secured loan is treated differently from an unsecured loan within bankruptcy proceedings. With a secured debt, the lender can repossess the collateral if the borrower cannot repay the loan.
The order in which these debts are paid through liquidation is called debt hierarchy. Generally, the first to be paid are secured debts or secured loans; secondly, preferred creditors (which are specific kinds of unsecured lenders); thirdly, general unsecured lenders; fourthly, general unsecured loans; and lastly, shareholders.
Car Loan Options in Chapter 7
As mentioned earlier, there are a few general options for handling car loan payments with bankruptcy: reaffirmation, redemption, or surrender. Here is more information about your car loan choices when you file for bankruptcy:
| Option | Description | Key Considerations |
| Reaffirmation | Entering into a new contract with your lender, called the reaffirmation agreement. | – You must be able to continue making payments. – Court approval may be required. |
| Redemption | Paying the lender the vehicle’s fair market value rather than the existing loan amount allows you to keep your car. | – You need a lump sum payment to cover the fair market value. – This can be beneficial if the car’s value is less than the loan amount. |
| Surrender | Give up your vehicle, which will discharge the car loan. | – You no longer have to make loan payments. – You lose possession of the car. |
Reaffirmation of Car Loan
If you want to proceed with debt reaffirmation, you’ll have to complete the correct paperwork when filing for bankruptcy. You can talk to your lender beforehand or after this about negotiation. If your lender does agree to negotiate, they will send you the reaffirmation agreement. If you do not have an attorney, you may have to go to bankruptcy court with your reaffirmation agreement to move forward—this is in your best interest.
If you decide to move forward with reaffirmation, you will continue repaying your car loan within the new terms established in the new agreement. As long as you abide by the terms after you reaffirm your loan, you should be able to keep your car after bankruptcy, which is the main benefit of this type of agreement. Other benefits may include the ability to build positive payment history.
Some risks of reaffirmation include unfavorable terms and the fact that you will have to continue making payments to a lender even after bankruptcy, which can take a toll on your financial situation.
Redemption of Car Loan
Redemption with a car loan is when you pay the lender the vehicle’s fair market value, rather than what is left on the loan. Redeeming will only make sense if you have an upside-down car loan.
To redeem your loan, you’ll have to file a motion to redeem it in bankruptcy court, and you’ll have to provide documents that show the value of your car, which the lender can either accept or reject. If they don’t agree to your evaluation, there will be a court hearing in which the car’s value will be decided. Once approved by the court, you’ll have to make a lump sum payment for the bankruptcy redemption.
Two obvious benefits of car redemption is that you may end up paying less for it than if you had continued making payments through something like reaffirmation and keeping your car. One benefit that you may not be aware of is that once you pay the lender, it can help your credit scores.
Some risks of car redemption can include paying more if the car’s value is higher than what you have left on the loan. Additionally, redemption may mean paying more in legal fees if the lender disputes.
Surrendering the Vehicle
The final option that you can consider with your auto loan is vehicle surrender. Just like the other two options, you will have to state that you want to go through surrendering your car.
You’ll then have to inform your lender about the surrender. From here, you can come up with an arrangement to return your vehicle to the lender. The next step involves the creditor selling the vehicle to cover the car loan balance. If the vehicle’s value is not enough for the amount due, the debt will be discharged. A bankruptcy trustee should keep track of all these steps/paperwork, etc.
The main benefit of surrendering your vehicle is that you won’t have to pay anything out of pocket or have an ongoing car payment, which can be huge financial relief. However the main drawback of this is that, of course, you will have to relinquish your car in bankruptcy.
Impact of Chapter 7 on Credit Score
Chapter 7 bankruptcy will have both short-term and long-term effects on your credit score. The short-term, immediate impact will be as follows:
- Your credit score will drop significantly after Chapter 7 bankruptcy.
- Creditors with whom you have existing accounts will likely reduce credit limits or might close accounts.
- You will likely have a hard time finding new borrowing options until you take time to rebuild your credit.
Some long-term impacts on your credit score will include:
- The bankruptcy will be listed on your credit report; it can stay there for up to 10 years.
- The negative impact on your credit score can take several years to rebuild.
- Securing loan options like mortgages, business loans, or auto loans will be difficult for the first few years or longer.
- Having a bankruptcy on your credit report can impact your ability to rent.
- In some cases, your insurance rates may be impacted.
Importance of Seeking Legal and Financial Advice
While bankruptcy can mean debt relief, it can be extremely devastating for your finances, and for many, it should be a last resort. Before you go through this filling, it is essential that you seek the assistance of experts.
A financial advisor can provide you with the financial guidance that you will need during this time, while a bankruptcy attorney can provide you with legal counsel and legal advice before, during, and after bankruptcy filing.
Consider CreditNinja For Your Debt Resolution
When you have an active car loan with Chapter 7 bankruptcy, things can get a little complicated. But the good news is that you’ll have options, and some of them will allow you to keep the vehicle. You can decide to reaffirm, redeem, or surrender your vehicle. All of these options have their sets of pros and cons, and it’s important to review them very carefully before deciding on the best option for you.
If you are deciding to go the redemption or reaffirmation route, CreditNinja may be a solution. We offer personal loans for emergency situations like this one. If you need some funds to continue car payments or to make a lump sum payment to a car lender, our loan options may work for you. To learn more about our loans, check out our personal loan page.
FAQs On What Happens to Your Car Loan When You File Chapter 7 Bankruptcy
Under Chapter 7 bankruptcy, a car loan is not automatically forgiven. However, you have options depending on the vehicle’s equity and your bankruptcy exemptions. If the vehicle equity is covered by your motor vehicle exemption or the federal wildcard exemption, you can keep your car by continuing to make car payments. If the balance owed on the car loan exceeds the vehicle’s equity, you may choose to surrender the car and discharge the remaining debt. Alternatively, you can redeem the car by paying its current value in a lump sum.
In bankruptcy, what happens to a car loan depends on whether you file for Chapter 7 or Chapter 13. Under Chapter 7, you can either reaffirm the car loan, redeem the vehicle, or surrender it. Under Chapter 13, you can include the car loan in your repayment plan.
Deciding whether to give up your car in bankruptcy depends on several factors, including the car’s value, exemption limits, and your ability to make ongoing payments. If the vehicle’s equity exceeds the motor vehicle exemption and the federal wildcard exemption, you might need to surrender the car unless you can pay the nonexempt equity to the bankruptcy trustee. Additionally, if keeping the car would strain your finances due to high monthly payments or past due payments, it might be beneficial to surrender the car and discharge the debt.
If your car was never repossessed after filing for Chapter 7, it could be due to you reaffirming the car loan or redeeming the vehicle by paying its current value. If neither of these actions were taken, and the car was not included in the surrender list, you are still responsible for making payments to keep the car.
The average interest rate on a car loan after Chapter 7 bankruptcy is typically higher than standard rates. Rates can vary widely based on your credit score, the lender’s policies, and current market conditions.
This exemption allows you to protect a certain amount of your vehicle’s equity from being used to pay creditors in bankruptcy. The exemption amount varies by state, and in some cases, you can also use the federal wildcard exemption to protect additional equity. If the car’s equity exceeds the exemption limit, you may need to pay the nonexempt equity to the bankruptcy trustee or risk losing the car.
References:
Which Creditors are Paid First in Liquidation | Investopedia
How Do I Renoegoiate My Car Loan in Bankruptcy | Legal-Info
The Motor Vehicle Exemption Under Bankruptcy Law | Justia
