So when you file a Chapter 7 Bankruptcy, your options related to a car are generally limited, as opposed to a Ch. 13 where we can in many cases, cure delinquencies, lower your interest rate, or even reduce the balance on the vehicle loan.
Unfortunately, all of those options in a Ch. 13 come with a price, including a long repayment plan, higher attorney's fees, and a generally more complex Bankruptcy.
When it comes to a Ch. 7, oftentimes, as Bankruptcy attorney we only offer you two choices: surrender the vehicle, or reaffirm the loan and keep the vehicle with the same loan terms.
The problem is that vehicles are generally really bad investments, and when your credit is bad, your interest rate is so high that as you pay down the loan, the vehicle depreciates much faster than your loan is paid off, and in a few short years, you owe so much more than the car is worth.
Many clients have a car that is perfectly reliable, but they are so upside-down on the vehicle that reaffirming the loan during the Bankruptcy is really a bad financial move.
So what can you do?
There is a third option that is not very popular, but it is something that you should be aware of if you are in a Ch. 7 Bankruptcy and you want to keep a vehicle that is worth substantially less than your loan balance.
That option is called a “722 Redemption”. In Bankruptcy, a motion to redeem (found under 11 U.S.C. Sec. 722) allows a debtor in Bankruptcy to pay the car lender the value of the vehicle in on lump sum and discharge the unsecured balance of the loan.
For example if you had a 10 year old Honda Civic, and the car was worth $8,000, but the loan balance was $19,000, you could file a motion to “redeem” and pay the lender $8,000 in one lump sum, and the remaining balance of the loan (which is unsecured) of $11,000 would get discharged in the due course of the Bankruptcy.
Now while that sounds well and good, most people don't have a lump sum to pay off their car loan, unless the vehicle is not worth very much money. Of course, where there is a need, the market responds, and there are many companies out there that will finance a loan like this, and allow you to “redeem” your vehicle.
So let's go over the pros and cons. The obvious advantage is that you can keep your car and only pay back the current Blue Book value of the vehicle.
But there are some downsides that you should be aware of.
The biggest downside is exactly the same as a reaffirmation agreement…you are stuck with the car on a long-term basis. My advice is to always determine the length of the remaining loan term (e.g. 48 months), and figure out if the car will still be reliable based upon how much driving you do, at the end of that term. If the car breaks down during the new loan, you don't have the option of giving the car back without owing the balance of the car loan.
The next downside is that most companies that are willing to finance your vehicle redemption charge high interest rates. Having said that, the interest rates are not much different than a regular auto loan that you would qualify for after your Bankruptcy case is concluded, but it is a consideration. Remember, the more you finance the harder it is to keep pace with the vehicle depreciation during the life of the loan.
Another downside is that you will probably need to have your attorney draft the motion. Many of the redemption finance companies will actually prepare the motion documents for your attorney, but you should expect your attorney to charge you for their time. In some cases, the finance company will actually bake the attorney's fees into your new auto loan, so you should talk with your Bankruptcy attorney about this option (preferably before you file) to find out how they handle such motions.
Finally, you should take the time to do some research on your vehicle and determine if there is any reason why the vehicle might not actually be worth the Blue Book value. Oftentimes the online Blue Book values are not reflective of what your vehicle is actually worth, especially if there have been recalls, or if that vehicle is well known to have problems after a certain number of miles. In some areas, certain styles of vehicle are overrepresented in the secondary (used) market, and therefore, the vehicle is not actually worth the actual Blue Book value. Also, since there are several options for vehicle valuation (e.g. Kelley Blue Book, NADA Guide, Edmunds, etc.), you can expect that your vehicle finance company will look at the service that values your vehicle higher than what the 722 redemption financing company may value it at.
All of those downsides are important, but they are not significant enough to rule out redeeming your vehicle under Sec. 722 of Title 11 if the economics of keeping the vehicle weigh in your favor. As always, your Bankruptcy attorney is the best source of information for your specific circumstances, and you should try to discuss this with your attorney as early in the process as possible.
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