Keeping Your Car In Bankruptcy
Unless you are lucky enough to live in an area of town with good access to the light rail, you probably have a car to get you around town. Many people contemplating a bankruptcy are concerned about losing their car. After all, without a car, how are they to get to work and make the money necessary to become credit independent? Let’s look at the nuances of how cars are treated in an Arizona bankruptcy.
The $5,000 Vehicle Exemption
Arizona provides a $5,000 exemption for equity in one vehicle, but these principles apply equally in most states with a vehicle exemption. You need only adjust for the amount of the exemption. If you do not have a loan on your car, your equity is simply the value of your car. If, on the other hand, you have a loan secured by your car you will need to calculate how much your car is worth beyond the outstanding loan balance. To get a decent valuation you should use a website like Kelley Blue Book or NADA. Lender will want you to use the Used Retail Value. If your vehicle is is good to excellent shape, then you probably will have to use the Used Retail Value. If your vehicle has issues, however, then it may not be salable at a Used Retail price and you should value it at something appropriate that takes into account the economic realities faced by the lender if it were to be sold at auction. Then take a look at your loan balance. Your “equity” is the difference between the two. If you have negative equity you are what is called “upside down” — and strangely — you may actually get to turn yourself right-side-up through the Bankruptcy. I will discuss that a bit later.
Example 1: No Equity
Let’s say you own a 2008 Volkswagen Rabbit with 35,000 miles in good condition. Kelley Blue Book says it is worth $10,000. However, you purchased the car for $18,000 a couple years ago and still owe the bank $12,000. You are in the classic upside down position and have no equity.
Example 2: Equity
Let’s say you own the same 2008 Volkswagen Rabbit worth $10,000 but you took out a shorter term loan and only owe $8,000 to the bank. Now you have $2,000 in equity. Because you are allowed up to $5,000 in equity, you will be able to protect this car in a Bankruptcy assuming you are okay keeping the loan.
Example 3: Excess Equity
Now let’s say you own the same Rabbit but instead owe the bank only $2,000. You have $8,000 in equity and can protect up to $5,000 in bankruptcy.
Car Loans in Chapter 7
If you have a car loan and file Chapter 7 you will have essentially 3 options:
- You could surrender the vehicle to the lender;
- You can redeem the vehicle by paying the full used retail value and asking the Court to force the lender to release its lien (usually via a redemption loan–often referred to as a 722 redemption loan); or
- You could reaffirm your obligation to the lender and render yourself potentially liable on the loan post-Bankruptcy. Some lenders will allow a 4th option, which used to be called a “ride through” and is sometimes called “pay and retain.” This method allows a debtor to retain the vehicle simply by making voluntary payments. Most lenders are hip to the fact that this option was eliminated with the Bankruptcy Revisions of 2005 and, therefore, they will threaten to repossess if you do not reaffirm. Most of my clients do not want to call their bluff and end up reaffirming.
If faced with the options of reaffirming or simply doing a ride through, there are a few considerations. If a reaffirmation agreement is entered, the debt is essentially pulled out of the bankruptcy and you could be liable on the promissory note. Thus, if you decide to reaffirm but 1 year after the bankruptcy end up missing payments and the vehicle is repossessed, you would be liable for the deficiency balance. If you had chosen to simply ride through or make voluntary payments you would not have been liable in the same scenario. So why reaffirm if you don’t have to? The main reason is that it looks better on your credit report. If you are going to be making regular payments anyway, it is often better for your credit that these payments be reported. Without a reaffirmation, your credit report will simply reflect that the loan was discharged, even if you are still making payments to keep the vehicle.
To exercise your options to retain the vehicle you will generally need to be current on your payments going into the Chapter 7. If you are behind on your payments, you may want to consider a Chapter 13.
Car Loans in Chapter 13
Chapter 13 offers a few more options for dealing with car loans. If you decide to retain your vehicle in a Chapter 13, you will need to know whether your loan is more than 910 days old (2.5 years). If you took out the loan more than 910 days prior to filing Bankruptcy, then you only have to pay back the fair market value of the car. In my example above where the car was worth $10,000 but you owed $15,000 that means you would only have to propose a repayment plan that pays back $10,000. This is a great deal considering that in a Chapter 7 you would have had to reaffirm the full amount unless your lender agreed to voluntarily reduce the balance to fair market value. If your loan is less than 910 days old, you will have to pay back the full loan over the course of your Chapter 13 plan. However, because Chapter 13 plans last 36-60 months, you will often lower your monthly payment considerably by spreading the loan amount over a longer period.
Chapter 13 also offers the ability to catch up when you are behind on payments. Your plan can provide to repay the missed payments and catch you back up. As long as you are making your plan payments and adequate protection payments to your lender, they will not be able to repossess.
If you are married and filing Bankruptcy you get to double your vehicle exemption. That means you can exempt two vehicles with $5,000 in equity in each. You may also stack your exemption so that you claim one vehicle exempt up to $10,000 in equity. Unfortunately, you cannot split the exemption by spreading the total $10,000 in exempt equity between two cars where one of the cars is worth more than $5,000 and the other is worth less than $5,000. For example, if you are married with one car worth $2,000 and another car worth $8,000, you cannot exempt both cars. In this scenario it would be a better deal to stack the $10,000 exemption onto the more expensive car and arrange to repurchase the lesser car from the Trustee (assuming you file for Chapter 7).
Buying Back Your Cars With Excess Equity
If you have excess equity and file a Chapter 7, you can make an offer to your case Trustee to purchase your vehicle back from the Bankruptcy Estate. You will be allowed to credit bid your $5,000 vehicle exemption. For example, let’s say you have $8,000 in equity in your car. You will be allowed to credit bid your $5,000 and pay the rest in cash, usually at a discount. To retain your car you would then have to pay $3,000 (or less if you work out a better deal with your Trustee).