Filing for bankruptcy can be a lifeline when you’re overwhelmed by debt, but it also raises many questions about your existing financial obligations, including your car loan. If you’re struggling with both credit card debt and an auto loan, understanding the implications of bankruptcy on your car loan can help you make informed decisions.
Here’s what happens to your car loan if you file for bankruptcy and what you need to consider.
Types of Bankruptcy and Their Impact on Car Loans
There are two main types of bankruptcy filings for individuals: Chapter 7 and Chapter 13. Each has different effects on your car loan, so it’s important to understand the distinction.
Chapter 7 Bankruptcy
Chapter 7 bankruptcy, also known as liquidation bankruptcy, involves selling your non-exempt assets to pay off your debts. If you file for Chapter 7, your car loan is impacted in the following ways:
- Car Loan Debt is Discharged: In some cases, Chapter 7 may discharge your car loan debt, meaning you are no longer responsible for paying it. However, if you want to keep the car, you must continue making your loan payments.
- Surrendering the Car: If you’re unable to continue making payments or don’t want to keep the car, you can choose to surrender the vehicle. The lender will take possession of the car and sell it to recover the loan balance. Any remaining debt after the sale may be discharged in bankruptcy.
- Reaffirmation Agreement: If you wish to keep the car and avoid the risk of repossession, you may be able to enter into a reaffirmation agreement with your lender. This agreement means you continue making payments as originally agreed, and the debt is not discharged in bankruptcy. If you fail to make payments, the lender can repossess the car.
Chapter 13 Bankruptcy
Chapter 13 bankruptcy is a reorganization bankruptcy where you propose a repayment plan to pay off your debts over 3-5 years. The effect on your car loan can vary:
- Restructuring Car Loan Payments: In Chapter 13 bankruptcy, your car loan may be included in the repayment plan, where the loan balance is restructured to make payments more affordable. The loan might be reduced or even extended, depending on the value of the car and your financial situation.
- Car Loan Can Be “Crammed Down”: If the car’s current value is significantly less than what you owe (for example, if you’re upside down on the loan), you might be able to “cram down” the loan. This means the court may reduce the loan balance to the car’s actual value, and you would only have to repay that amount. However, this only applies to loans taken out more than 910 days before filing for bankruptcy.
- Continuing Payments: If your car is not included in the Chapter 13 plan, you must continue to make payments on it outside of the plan to avoid repossession. The court may allow you to adjust the terms of the loan as part of your repayment plan.
What Happens If You Fall Behind on Car Payments Before Filing for Bankruptcy?
If you are behind on car payments and facing the threat of repossession, bankruptcy can offer a temporary reprieve, but it depends on the timing and type of bankruptcy:
- Automatic Stay: Once you file for bankruptcy, an automatic stay goes into effect, which temporarily halts creditors from taking collection actions against you, including repossession. If you are behind on car payments, this can give you time to catch up or reorganize your debt. However, the stay is only temporary, and creditors can ask the court to lift the stay if they can demonstrate that you are not making efforts to repay the debt.
- Reaffirmation and the Car: If you want to keep your car but are behind on payments, you may need to reaffirm the loan in Chapter 7 or include it in your Chapter 13 repayment plan. If the car is essential for your daily life and transportation, bankruptcy might give you the opportunity to keep the car, even if you have missed payments.
The Effect of Bankruptcy on Car Loan Interest Rates
Filing for bankruptcy will likely affect your credit score, which can result in higher interest rates on future car loans or other credit accounts. While bankruptcy does not automatically make it impossible to secure a car loan in the future, expect to pay higher interest rates due to your decreased creditworthiness. Over time, as you rebuild your credit, you can qualify for better rates.
Can You Keep Your Car After Bankruptcy?
The answer depends on the specifics of your case:
- Chapter 7: If you can afford to continue making payments, you can keep your car, but you may need to reaffirm the loan or continue paying as agreed. If you can’t afford the payments, you may need to surrender the car.
- Chapter 13: As long as you are making the payments as outlined in your repayment plan, you can keep the car. The loan might be restructured, and the amount you owe could be reduced.
Alternatives to Bankruptcy
If you’re struggling with your car loan but are unsure about filing for bankruptcy, consider alternatives like:
- Loan Modification: Speak with your lender about modifying the terms of your car loan. This could include reducing your interest rate or extending the loan term to make payments more affordable.
- Refinancing: If your credit is still in good standing, you might be able to refinance your car loan for better terms, which could lower your monthly payments.
- Debt Consolidation: If you have other debts along with your car loan, consolidating them into one loan could simplify your finances and potentially reduce your overall interest rate.
Conclusion
Filing for bankruptcy can be a way out of overwhelming debt, but it also has significant consequences for your car loan. Whether you choose Chapter 7 or Chapter 13, the effects of bankruptcy on your car loan will depend on factors like the type of bankruptcy, the value of the car, and your ability to make payments. It’s important to fully understand your options and seek legal advice to determine the best course of action for your specific situation.
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