Your Vehicle Loan Options in a Chapter 7 “Straight Bankruptcy” Case

For many people, no debt has more practical importance than their car or truck loan.

 

Whether you want to keep your vehicle or get rid of it, and whether you are current or behind on your payments, Chapter 7 bankruptcy strengthens your hand in every way.

The “Automatic Stay” Gives You the Chance to Decide to Keep or Surrender

As long as you file your Chapter 7 case before your vehicle gets repossessed, your lender can’t repossess it once you do file. The same “automatic stay” law that stops all your creditors from calling you, suing you, and garnishing your wages also stop your vehicle lender from repossessing your vehicle—at least for a month or so while you decide whether to keep your car or not, if you haven’t already decided one way or the other.

Surrendering Your Vehicle

If you decide to surrender your vehicle, Chapter 7 bankruptcy is often the best way to do so. The reason is because with most vehicle loans even after surrendering the vehicle you would still owe money to your lender after the surrender, often a much larger amount than you would think. This “deficiency balance” is the amount you owe after the lender repossesses the vehicle, sells it—usually at an auto auction, pays itself its costs of repossession and sale out of the proceeds of sale, and then pays the rest of the proceeds towards your loan’s interest, late fees, and principal balance.

Because of the relatively low sale price of your vehicle at an auto auction, and the relatively high repossession and sale costs, in the end you often have a very hefty debt, and no vehicle. Because at that point you’re understandably not all that motivated (or able) to pay this remaining debt, the lender would then usually sue you to make you pay it.  

 

Surrendering your vehicle during your Chapter 7 case allows you to legally and permanently write off (“discharge”) that entire remaining debt, instead of having it hang over you.

Keep Your Vehicle

If you want to keep your car or truck, whether you are current on your loan, and if not how quickly you can catch up, are crucial.

If You Are Current

If you want to keep your vehicle and are current at the time your Chapter 7 case is filed, and can keep making the payments on time (especially after discharging your other debts), it’s simple: you can essentially keep your vehicle loan out of your bankruptcy case. You’d usually sign a “reaffirmation agreement” stating that you intend to hang onto your vehicle and giving your consent to not discharging the vehicle loan in your Chapter 7 case.

If you owe more on the loan than your vehicle is worth, you should think twice about signing a “reaffirmation agreement.” That’s because doing so makes you continue to be liable on a debt you could be discharging in bankruptcy. Instead carefully consider whether you should surrender it and dump the debt. It’s your one chance to do so. Otherwise you would risk being unable to make your payments later, losing the vehicle to repossession, and owing a large deficiency balance because you had “reaffirmed” the debt in your bankruptcy case.

Unfortunately you can’t “have your cake and eat it too”: you usually can’t keep a vehicle that you owe on without reaffirming the debt. Most conventional vehicle loan creditors insist that you sign a “reaffirmation agreement” for the full balance of the loan, even if your vehicle is worth less than that.

But sometimes, especially with smaller lenders, you may be able to avoid “reaffirming” the vehicle debt, or can “reaffirm” at a lower balance. Talk with your attorney about what’s possible with your own lender.

If You Are Not Current

If you want to keep your vehicle and aren’t current on the vehicle loan at the time your Chapter 7 case is filed, your options are limited. You would usually need to get current very quickly to be able to keep the vehicle—usually within a month or two. Most vehicle lenders will not allow you to skip the missed payments or even to catch up on those payments over time—although a minority of them will allow some flexibility.

But for the majority of lenders who insist on a full “reaffirmation” of the vehicle loan balance, they’ll demand that you get current within weeks after you file your case. One reason is because for a “reaffirmation agreement” to be legally valid, it has to be filed with the bankruptcy court before the debt is discharged, which happens in most cases about three months after it’s filed. So the lender insists that you get current well before that so that the “reaffirmation agreement” can be prepared, signed, and filed at court in time.   

Again, talk with your attorney to find out if your lender is one of the uncommon more flexible ones.

Much greater Flexibility through Chapter 13

If you need or want to keep your car or truck but are behind on payments and can’t catch up within a month or two after filing, consider the Chapter 13 “adjustment of debts” option instead of Chapter 7. Chapter 13 may not only give you more time to catch up on those back payments, but may even substantially reduce your monthly payments, the interest rate, and the total amount to be paid on the loan. I’ll discuss these Chapter 13 tools in my next blog post.

 

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Secured Debts, the Focus of Many Bankruptcies

Debts secured by liens on your property or possessions often grab the most attention during a bankruptcy case.

 

“General unsecured” debts, discussed in my last two blog posts, are handled in a relatively straightforward fashion in bankruptcy. In a Chapter 7 case, they are generally discharged (legally written off) without any opposition by the creditors. Those creditors usually get nothing. And in a Chapter 13 case, “general unsecured” debts often are paid simply whatever money is left over, if any, after the secured and priority debts and the trustee and attorney fees are paid. There’s because the creditors usually don’t have much to fight about.

But with secured debts—debts secured by collateral or through some type of lien—your property or possessions that are providing security are often a point of contention.

The next few blog posts will be about how to use Chapter 7 or Chapter 13 to deal with the main kinds of secured debts. Today I start with some important points that apply to most secured debts.

Two Agreements in One

A secured debt effectively involves two interrelated agreements between you and the creditor. First, the creditor agreed to give you money or credit in return for your promise to repay it on certain terms. Second, you gave the creditor certain rights to the collateral, including the ability to take that collateral from you if you don’t comply with the terms of your promise to repay the money.

Generally, bankruptcy will only undo that first agreement—your promise to pay. In contrast, your creditors’ rights to collateral generally survive bankruptcy.

The Value of Collateral

How much the collateral is worth as compared to the amount of the debt becomes very important as to what happens to that collateral.

If the collateral is worth a lot more than the amount of the debt, this debt is considered well-secured. Then there’s a much better chance that the debt would be paid in full.  You’ll really want to pay off the relatively small debt to get the relatively expensive collateral free and clear of that debt. Or if you didn’t make the payments the creditor will get the collateral and sell it for at least as much as the debt.

If the collateral is worth less than the amount of the debt, the debt is considered undersecured. It’s less likely that such a debt would be paid in full because in return you’d get collateral worth less than what you’re paying.

Depreciation of Collateral, and Interest

Since the value of the collateral is such an important consideration for a secured creditor to be made whole, the loss of its value through depreciation is something that creditors care about, and about which the bankruptcy court respects.

Also, in most situations secured creditors are entitled to interest. So, you’ll see in our next blog posts that when there are conflicts with secured creditors—on home mortgages or vehicle loans, for example—issues about depreciation and interest become important.

Insurance

Virtually every agreement with a secured creditor—definitely those involving vehicles and homes—requires that you carry insurance on the collateral. If the collateral is damaged or destroyed, this insurance usually pays the debt on the collateral before it pays you anything. And, if you don’t get the required insurance, the creditor itself can buy insurance to protect only its interest in the collateral AND charge you for it.

 

With these points in mind, the next blog post will tell you your options with your vehicle loan under Chapter 7.

 

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What Happens to Most of Your Debts under Chapter 13 “Adjustment of Debts”?

In most Chapter 7 “straight bankruptcy” cases most debts are written off, so what happens to them in a Chapter 13 “adjustment of debts”?

 

The Advantages and Disadvantages of Chapter 13

Chapter 13 comes with many, many tools not available under Chapter 7. Many of these tools are helpful particularly if you have special debts or issues not deal with well in a Chapter 7 case—if you are behind on your mortgage, vehicle loan, or child support, if you owe income or property taxes, or if you have non-exempt (unprotected) assets you want to keep.

But these advantages come with what can be a significant disadvantage: you would usually have to pay something on your “general unsecured” debts—your run-of-the-mill ones without any collateral. That’s instead of paying nothing, as you likely would in a Chapter 7 case.

In some rare Chapter 13 cases you have to pay your “general unsecured” creditors in full—a so-called 100% plan. But on the other extreme, you may not have to pay those creditors anything—a 0% plan. Most of the time you have to pay them something, but often very little—only a few cents on the dollar.

How Much Do You Need to Pay Your “General Unsecured” Debts?

You must pay these debts whatever money is left over and available based on your budget after paying certain secured debts (home mortgage and vehicle arrearage, for example) and “priority” debts (recent income taxes, for example). So how much you have to pay on the debts that in a Chapter 7 case would be just discharged (written off without any payment) depends on your income, allowed expenses, and other debts, and sometimes also on the value of assets that you are trying to protect.

Here is a list of considerations in greater detail about how this works under Chapter 13.

1. Debts that are legally the same are treated the same. So, in a Chapter 13 plan all “general unsecured” debts are paid the same percent of the debt as are other “general unsecured” debts.

2. For any creditor to get paid anything out of what you are paying into a Chapter 13 plan, it has to file a “proof of claim”—stating the amount and nature of the debt—with the bankruptcy court, and do so by the stated deadline. If a creditor with a “general unsecured” debt does not file a “proof of claim” it will receive nothing through the plan. The debt will then be discharged at the end of the completed case.

3. If, as is often the case, other creditors do not file proofs of claim that usually, but not always, means more money available for the other creditors.

4. “0% plans” are those in which all of the money paid by the debtor into the plan is earmarked to pay secured and “priority” debts, plus trustee and attorney fees, leaving nothing for the “general unsecured” ones. Some bankruptcy courts frown on “0% plans,” either in general or especially when there does not seem to be good reason to be in a Chapter 13 case instead of a Chapter 7 one.

5. “100% plans” are those in which all of the “general unsecured” debts are paid in full through the plan. These happen mostly for two reasons. The debtors:

a. have enough disposable income (income minus allowed expenses) over the course of the case to pay off their debts in full; or

b. own more non-exempt assets which they are protecting through their Chapter 13 case than they have debts, requiring them to pay off their debts in full in order to keep those assets.

6. How much “general unsecured” debts are paid depends in part on how long the debtors are required to pay into their Chapter 13 case. Generally, if debtors’ pre-filing income is less than the published “median income” for their applicable state and family size, then they pay for 3 years into their plan. If their income is more than that amount, they must pay for 5 years instead.

7. Payments on “general unsecured” debts can also be affected by changes that happen during the case, such as income increases or decreases affecting the monthly plan payment amount, and unexpected tax refunds and employee bonuses paid into the plan.

8. Once the “general unsecured” debts are paid whatever the Chapter 13 plan provides for them (and the rest of the plan requirements are met), the remaining balances of those debts are discharged.

 

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What Happens to Most of Your Debts in Chapter 7 “Straight Bankruptcy”?

Your debts that are not secured by collateral and are not “priority” debts are discharged (written off) and paid nothing. Mostly.

 

In my blog post last week I introduced the three main categories of debts: “secured,” “priority,” and “general unsecured.”

Secured and priority debts tend to be the ones with issues worth talking about. Secured debts often have liens against your important property and possessions—your home, your car or your truck, maybe your furniture and appliances. Priority debts are ones that are usually not secured but are favored in various ways in the law. They include child and spousal support, certain taxes, and such.

It’s worth paying a lot of attention to secured and priority debts because they raise questions that are likely important to you. Such as, how does bankruptcy help you keep your car if you are behind on payments? If you file a Chapter 7 case do you have to keep paying on your furniture loan to keep your bedroom furniture, and if so how much? How can filing bankruptcy enable you to get and/or keep current on your child support? Will you be able to write off any of your overdue income taxes?

We will look into these questions and more about secured and priority debts in upcoming blog posts. And yet, you probably have more of the third category of debts, “general unsecured” ones, than either secured or priority debts. So first let’s look at what happens to your general unsecured debts, covering today what happens if you file a Chapter 7, and then in my next blog post what happens under Chapter 13.

General Unsecured Debts  

First a reminder from last week: general unsecured debts are those that don’t belong in the other two categories. They are unsecured in that they have no lien on any of your property or possessions. They are “general” simply in that they are not one of special “priority” debts that the law has selected for special favored treatment.

General unsecured debts include all sorts of obligations. Besides the most common ones like (most) credit cards and medical bills, they include personal loans without collateral, checking accounts with a negative balance, bounced checks, most payday loans, claims against you for property damage and personal injury, for breaches of contract—again, just about any way that you can owe money without collateral.

What Happens to Most General Unsecured Debts in Most Chapter 7 Cases

All these kinds of general unsecured debts are usually just legally, permanently written off—“discharged”—in a Chapter 7 bankruptcy case. That means that once they are discharged—usually about 3 months after your case is filed—the creditors can take absolutely no steps to collect those debts.

The only way those debts are paid anything is if either 1) the debt is NOT dischargeable or 2) it is paid (in part or in full) through an asset distribution in your Chapter 7 case.

 1) “Dischargeability”

A creditor can dispute your ability to get a discharge of your debt. Very few general unsecured debts are challenged and so they get discharged. In the rare case that the discharge of one of your debts is challenged, you may have to pay some or all of that particular debt. That depends on whether the creditor is able to establish that the facts fit within some quite narrow grounds. That would usually involving allegations of fraud, misrepresentation or other similar bad behavior on your part. If the creditor fails to establish the necessary grounds, the debt is discharged.

There are also some general unsecured debts that are not discharged unless you convince the court that they should be, such as student loans. The grounds for discharging student loans are quite difficult to establish.

2) Asset Distribution

If everything you own is exempt, or protected, then your Chapter 7 trustee will not take any of your assets from you. This is what usually happens—you’ll hear it referred to as a “no asset” case. But if the trustee DOES take possession of any of your assets for distribution to your creditors—an “asset case”— your “general unsecured creditors” may, but often don’t receive some of it. The trustee must first pay off any of your priority debts, as well as pay the trustee’s own fees and costs. The unsecured creditors get a pro rata share of the pool of whatever, if anything is left over.

Conclusion

In most Chapter 7 cases your general unsecured debts will all be discharged and most of the time will receive nothing from you. Rarely, a creditor may challenge the discharge of its debt. And if, again rarely, you have an “asset case,” the trustee may pay a part or—extremely rarely—all of the general unsecured debts, but only after paying all priority debts and his or her fees and costs.  

 

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