Your Car in Chapter 13 Bankruptcy

Can you and should you keep your car if you file for Chapter 13 bankruptcy?

If you're considering filing for Chapter 13 bankruptcy, you probably want to know what will happen to your car or truck. Does Chapter 13 bankruptcy let you keep your a car? Will the car be repossessed if you're behind on your loan or lease payments? And what happens if the car is worth less than the amount of the car loan? This article discusses when you can keep your car in Chapter 13 bankruptcy, whether you can reduce the amount of your car loan, how Chapter 13 bankruptcy affects repossessions, and more. (For information on your car in Chapter 7 bankruptcy, see Nolo's article Your Car in Chapter 7 Bankruptcy)

Keeping Your Car in Chapter 13 Bankruptcy

Generally, in a Chapter 13 bankruptcy, you keep your property, but you must use your income to pay some or all of what you owe to your creditors over time from three to five years through a repayment plan that's approved by the court. (To learn more about how Chapter 13 bankruptcy works, see Nolo's article An Overview of Chapter 13 Bankruptcy.)

If you are behind on your car loan or lease and you file for Chapter 13 bankruptcy, you can keep your car if you pay the arrearage (the amount you are behind) through your repayment plan and continue to make your regular car payments. As long as you stay current on your car loan and your repayment plan, the lender cannot repossess your car.

The Automatic Stay and Car Repossessions

When you file for Chapter 13 bankruptcy, most creditors are instantly prohibited from continuing collection efforts against you. This is called the "automatic stay." The automatic stay also prevents your car loan lender from repossessing your car. Here's how the automatic stay protects you in two different situations: When the lender has not repossessed your car before you file for bankruptcy, and when the lender has already repossessed your car when you file for bankruptcy.

No repossession when you file for bankruptcy. If the lender has not repossessed your car and you file for bankruptcy, the automatic stay prevents the lender from repossessing your car until the bankruptcy judge approves your repayment plan. Then, if your repayment plan deals with the back payments (the arrearage) on your car loan, the lender cannot repossess your car during and after the bankruptcy (assuming you stay current on your payments).

Although the lender cannot repossess the car due to having back payments, you must make "adequate protection" payments from the time you file for bankruptcy until your plan is approved. These payments are designed to cover the depreciation of your car during this time period. Usually, adequate protection payments are equal to the amount of your car payment. So, once you file for bankruptcy, keep on making your car payments until your plan is confirmed.

Your car is repossessed before you file for bankruptcy. In some cases, if your car is repossessed shortly before you file for bankruptcy, you may be able to get the car back if payment of the arrearage is provided for in your repayment plan and you are able to continue making your monthly payments. If your car has been repossessed and you plan to file for Chapter 13 bankruptcy, contact an attorney immediately.

Your Car Expenses Must Be Reasonable

First, let's look briefly at how a repayment plan works. In a Chapter 13 bankruptcy, your repayment plan must show that all of your disposable income that's your income minus your necessary living expenses is used to repay your unsecured debts under your repayment plan. In determining your disposable income, you may deduct only those expenses that are reasonably necessary for the support of you and your dependants. So, for example, you cannot deduct the cost of going to a fancy spa each month. This "reasonableness" provision might come into play if you own a luxury car. A court may decide that an exceptionally large car payment on an expensive luxury car is not a reasonable expense, and you might not be allowed to use that large car payment when computing your disposable income. Instead, you may only be able to claim an expense that would be consistent with a lower priced car.

If the amount of your car loan is greater than the value of your car (not an uncommon occurrence, because cars depreciate so quickly), Chapter 13 bankruptcy has a special provision that can reduce the amount of your loan. This provision, which applies to certain other forms of property as well, is called a "cramdown."

Here's how a cramdown works: The bankruptcy court can reduce your car loan so that it equals the replacement value of your car. (The replacement value is what you would pay a retail vendor given the car's age and condition.) The remainder of the loan amount becomes like any other unsecured debt, which is treated as a last priority in bankruptcy, meaning you may not have to pay it. Chapter 13 debtors usually pay only a small portion of their unsecured debt. In addition to reducing the principle on your car loan, the court will reduce the interest rate to between 1 1/2 and 2 percentage points above the prime rate.

For example, David's car loan is $8,000 and the interest rate is 9%. His car is worth $6,000. The cramdown reduces his car loan to $6,000, which he makes payments on as part of his bankruptcy repayment plan. The remaining $2,000 is added to his unsecured debt, towards which he ends up paying pennies on the dollar in hi Chapter 13 bankruptcy repayment plan. David's new car note carries an interest rate of 6%.

There's one catch to qualifying for a cramdown you must have bought the car more than two and a half years ago. Car loans for cars purchased within two and a half years of the bankruptcy filing cannot be crammed down. Also, you will have to complete your payments on the car within the term of your repayment plan. If your plan is for three years, you'll have to finish paying for the car in that time. This sometimes requires that your plan provide for a balloon payment at the end of the plan period.

Letting Your Car Go in Chapter 13 Bankruptcy

Sometimes it doesn't make sense to keep your car in Chapter 13 bankruptcy. If your car is worth less than your car loan and you don't qualify for a cramdown, it may be better to "walk away" and let the lender repossess the car. Even if you qualify for a cramdown, it still might make more sense to let the car go.

If you let the lender repossess your car, the lender will sell it, deduct the costs of repossession and sale from the sales proceeds, and then take the amount remaining on your loan. If there is anything left over (unlikely), you are entitled to any amount. Most often, the sale price minus repossession and selling costs is not enough to cover the amount of your loan. The difference between what you owe and what the lender was able to collect toward the loan is called the deficiency, which you now owe to the lender. In Chapter 13 bankruptcy, the deficiency becomes part of your unsecured debt. As mentioned above, you may pay some of your unsecured debt through your repayment plan, but the rest will be discharged at the end of the bankruptcy.

If you plan to give up your car, consider selling it yourself or negotiating with the lender to reduce the deficiency. For example, if you voluntarily turn the car in ("surrender" it), the lender may waive some or all of the deficiency. To learn more about surrendering your car to the lender, see Nolo's article When You Can't Pay Your Debts FAQ.

Car Leases in Chapter 13 Bankruptcy

If you have a car lease, the bankruptcy trustee (a court-appointed person who is in charge of your property during bankruptcy) can decide to assume the lease as property of the bankruptcy estate or reject the lease. Usually, the trustee will reject the car lease because the lease would not provide any value for your unsecured creditors. If that happens, you have two options:

Assuming the lease. You can assume the lease by continuing to make your payments outside of the bankruptcy repayment plan.

Rejecting the lease. You may choose to reject the lease and let the leaseholder repossess the car. The amount you owe under the lease contract becomes part of your unsecured debt, which is paid through your repayment plan. Like all unsecured debt, usually you pay only a portion of it and the remainder is discharged at the end of the bankruptcy.

For More Information

To file for Chapter 13 bankruptcy, or learn more about how it will affect your car, income, and other property, get Chapter 13 Bankruptcy: Keep Your Property & Repay Your Debts Over Time, by Robin Leonard and Stephen R. Elias (Nolo).