Feb 23, 2011

Reaffirming Car Loans in Bankruptcy

If you file for Chapter 7 bankruptcy, the lender may require you to reaffirm your car loan in order to keep the car. Here's why, and what happens if the reaffirmation agreement is, or is not, approved by the bankruptcy court.

When you are making payments on a car, your car note has two different parts -- the promissory note that makes you personally liable for the debt and the security agreement that allows the lender to repossess the car if you default on the payments. To be enforceable, the security agreement must be registered with the DMV or other state registry -- which results in a lien being placed on your car.

When you file Chapter 7 bankruptcy you can get rid of the promissory note (the amount you owe pursuant to the promissory note is discharged in the bankruptcy) -- and your personal liability -- but you can't get rid of the lien. This means you will have to continue making your payments if you want to keep the car, even though you don't actually owe anything on it. If your head is spinning by now, don't worry. It's hard to get a grasp on this principle.

Many Lenders Require Reaffirmation Agreements

Lots of lenders don't like the idea of borrowers being off the liability hook for the car note, especially if the loan is for a new model car. Not surprisingly, lenders look for ways to keep borrowers on the hook, so that the borrower is liable for any deficiency if the car is turned in or repossessed after the bankruptcy.

In 2005 Congress gave lenders the option of requiring borrowers to sign a reaffirmation agreement in order to keep the car after bankruptcy. In bankruptcy, reaffirmation simply means that the borrower will be liable after bankruptcy on the debt that is reaffirmed, whereas the borrower will not be liable without the reaffirmation.

If the lender requires you to reaffirm, you'll have to sign an agreement the lender will send you, and file the agreement with the court. The court will give you a date for a court hearing at which the judge will decide whether you can afford to make the car payments.

The Best Case Scenario: The Judge Doesn't Approve the Reaffirmation

If the judge decides you can't make the car payments, the judge will disapprove the reaffirmation agreement and you'll be off the hook. But what if you remain current on the payments, even though there is no reaffirmation agreement? In this case, you can keep the car.

Here's the rule: If the only reason you don't reaffirm the car note is because the judge has disapproved the agreement, you can keep the car just as if the lender had not required the reaffirmation the first place. If you want to read an explanation of this confusing and non-intuitive process, read the opinion in In re Moustafi, 371 Bankruptcy Reporter 434 (Bankr. Ariz. 2007). 

This means the best case scenario is that the judge disapproves the reaffirmation agreement. If the judge approves it, you'll be on the hook for the car note after your bankruptcy, which can be catastrophic if you later default on your payments and have the car repossessed.

To learn more about reaffirming a car loan in bankruptcy, and your other options for keeping your car in bankruptcy, read Nolo's article Your Car in Chapter 7 Bankrupty.