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Filing for bankruptcy is a serious decision that can damage your credit for seven or 10 years, depending on the type of bankruptcy. But if you're drowning in debt you can't pay, it can serve as a last resort to help you hit "reset" on your finances.
There are two main types of bankruptcy: Chapter 7, which liquidates some of your assets, and Chapter 13, which focuses on repaying debts. What happens to your car in bankruptcy depends both on the type of bankruptcy you file and how much equity you have in your vehicle.
Can You Keep Your Car After Filing Bankruptcy?
There are several factors that go into whether you'll be able to keep your vehicle through the bankruptcy process. Since your vehicle is considered an asset, and potentially a valuable one, it's something creditors may pursue when looking to collect debt. Your vehicle may, however, be counted under an exemption that protects it from repossession. In general, the following is considered to determine if you'll be able to keep your car:
- The type of bankruptcy you're filing
- Whether you own, lease or are still financing the vehicle
- The value of the vehicle
- What exemptions apply where you live
Read on to learn more about what you can expect to happen to your vehicle when you file bankruptcy.
What Happens to Your Car in Chapter 7 Bankruptcy?
Filing for Chapter 7 bankruptcy can clear some unsecured debts, but it may also require selling or giving up some assets to pay debts. The items that are exempt from liquidation, and the value that can be exempted, varies by state.
If you file for Chapter 7 bankruptcy and local bankruptcy laws allow you to exempt all of the equity you have in your car, you can keep the vehicle—as long as you're current on your loan payments. And if the market value of a vehicle you own outright is less than the exemption amount, you're in the clear.
To determine how much equity you have in the vehicle, subtract your current loan balance from the car's value. Because vehicles tend to depreciate in value fairly quickly, you may not have much equity unless you're nearing the end of your loan term.
Once you've determined how much equity you have in your vehicle, take a look at what the motor vehicle exemption is in your state. If you have less equity than the exemption limit, the car is protected. For example, if your state's exemption limit is $4,000 and you have $3,500 in equity in your vehicle, you can keep it.
If the equity in your car exceeds the exemption limit, a few different things can happen.
- The trustee (the person managing your bankruptcy case) can sell your vehicle, give you the exempted amount, and use the remainder to repay creditors. They may also give you the option to pay off the equity at a discount in order to keep the car.
- If you're behind on your vehicle loan payments, the lender can repossess the car. A vehicle is not protected by the exemption if the loan attached to the vehicle is delinquent. But you may be able to keep the car by paying the remainder of the loan in one lump sum, or by reaffirming the loan, which allows you to modify it and get back in good standing.
- You also have the option to surrender your vehicle to the lender, which removes your responsibility from the auto loan after bankruptcy. But doing so means you won't have a vehicle, and doing so will have credit consequences similar to repossession.
What Happens to Your Car in Chapter 13 Bankruptcy?
Another form of bankruptcy is Chapter 13, which works a bit differently from Chapter 7. Rather than liquidating non-exempt assets to repay creditors, you'll enter a debt repayment plan. Your property isn't sold off with this form of bankruptcy; instead, your finances are reorganized and you'll begin the process of repayment. If you own your car outright you'll be able to keep it.
You will have a repayment period of either three or five years, and once that period ends, some remaining debts can be discharged—meaning you don't have to pay them anymore. Not all debts can be discharged, however. Credit card and medical debt can be discharged, for example, but mortgages and student loans cannot.
When you file Chapter 13 bankruptcy, your debt is grouped into three buckets:
- Priority debts: These must be repaid in full. This includes bankruptcy costs, unpaid tax bills from the past three years, and child and spousal support.
- Secured debts: Car loans are included in this category. If you have a car loan, the amount you owe on it may be reduced in the Chapter 13 bankruptcy process if you owe more on it than its current value. Also, if you can qualify for a repayment plan and get caught up on your loan, you may be able to keep the vehicle.
- Unsecured debts: These will be discharged in the bankruptcy after you've completed your repayment plan.
Keep in mind that if you aren't able to catch up on your auto loan, or you can't afford repairs or payments on the car anymore, you can get out of payments by surrendering the car back to the lender, which, as mentioned, has credit consequences.
How Does Bankruptcy Affect Credit?
Both forms of bankruptcy can severely damage your credit for many years to come, so filing isn't an action that should be taken lightly.
Chapter 7 bankruptcy stays on credit reports for 10 years, while Chapter 13 bankruptcy sticks around for seven years. This means even nearly a decade after filing, potential creditors, lenders, landlords, utility companies and others legally allowed to view your credit will be able to see the bankruptcy on your report. Having bankruptcy in your history can cause you to be denied for new applications, such as for loans or credit cards. If a lender or creditor does approve you, you may face sky-high interest rates or fees.
During this time, though, you can help rebuild your credit by making wise financial decisions. If you pay all of your bills on time, avoid overspending, and use a secured credit card responsibly, you can slowly nudge your credit score back up.
Monitor Your Credit
Once you file for bankruptcy, it's wise to start monitoring your credit regularly. This allows you to see how the bankruptcy is affecting your credit as well as how any efforts you make to improve your score help rebuild it. It also helps you quickly see if there's any new activity on the report that shouldn't be there, such as errors or fraud that could harm your credit.