Nolo’s Bankruptcy & Foreclosure Blog

People often ask me about how Chapter 7 bankruptcy will affect their ability to keep their car. If you aren't making payments on a car, then it's just a matter of using whatever exemptions are available to keep it, just like any other asset. However, if you are making payments on your car, it's not so simple. As part of your bankruptcy you must decide how you want handle the note. You do this by filing an official form called the Statement of Intention (SOI) with your other bankruptcy papers as well as mailing a separate copy of the SOI to your lender.

If you want to walk away from the note, you list the lender on your SOI and state that you intend to surrender the vehicle -- that is, turn it in to the lender. This will clear you of any further liability on the debt after your bankruptcy. If you are leasing your car, you can get out of the lease by rejecting it on your SOI, or you can keep the car by assuming the lease. The choice is yours.

If you want to keep a car you are making payments on, the bankruptcy code gives you a choice between laying out a lump sum to purchase the car at its current value (called redemption), or entering into a new contract (called a reaffirmation agreement) which lets you keep your car under much the same terms as your original car note (although this is negotiable). In some cases, you can keep the car without entering into a reaffirmation agreement. Whether or not you have to enter into a reaffirmation agreement or can just keep making the payments -- called the ride-through option -- is up to your lender.

To find out what your lender wants, call them and ask for the bankruptcy or loss mitigation department. Explain that you intend to file for bankruptcy and ask whether you need to reaffirm the car note or whether you can retain the car and continue making payments without reaffirming. If the lender agrees to let you retain and pay, you won't owe anything on the debt after the bankruptcy but the lender will still have a lien and can repossess the car if you default on your payments.

No matter what else is going on in your bankruptcy, you should continue to make your payments as scheduled. If your lender accepts your payments, it's a sign that you will be able to retain the vehicle and continue making payments without reaffirming. Again, this is good because it means you can keep the car without worrying about any deficiency arising if the car is repossessed (or you decide to give it back) after your bankruptcy case is over. 

If the lender wants you to reaffirm, you must state on your SOI that you intend to reaffirm. The lender will send you an agreement setting out pretty much the same terms as your old agreement. As this point you should consider negotiating terms more to your advantage. You do have some leverage here in that bankruptcy gives you the option of surrendering the car and canceling all liability. Lenders lose a lot of money on repossessions and your lender may be willing to cut you a better deal, such as reducing the principal of the loan to the car's current value. Don't be afraid to attempt to negotiate. All they can say is "no."

Once you and the lender have agreed on the terms of the reaffirmation agreement, you must sign the agreement and file it with the court. A "discharge" hearing near the end of your bankruptcy will be set and the judge will decide whether the agreement should be enforced. In so deciding, the judge will consider your income, the amount you owe on the car, its value, and whether, given all these factors, the reaffirmation agreement would create an undue hardship or be against your best interests (typically because you'll continue to owe much more than the car's value).

If the judge approves the reaffirmation agreement, then you will be liable under its terms after your bankruptcy. For instance, if you owe $25,000 under the agreement and your car is only worth $10,000, you'll be on the hook for $15,000 or more should you have to give the car back due to a loss of income, and since you can't file another Chapter 7 bankruptcy for 8 years, that would truly be a debt from hell.

If the judge disapproves the agreement, according to several bankruptcy court opinions, you can keep the car as long as you remain current on your payments. These courts reason that as long as you do what is required of you by the bankruptcy code (state your intention to reaffirm, sign and file the reaffirmation agreement, and attend the discharge hearing) the fact that judge disapproves the agreement is beyond your control and should not result in your having to give up your car -- provided, of course, that you stay current on your payments. See In re Moustafi, 371 Bankruptcy Reporter 434 (Bankr Ariz 2007) (PDF).  In other words, you will be better off if the judge disapproves the agreement, since you will then have the equivalent of the ride-through option.

A couple of months before the government takeover of Freddie Mac and Fannie Mae, Congress passed a new law providing financial backing for these quasi-governmental agencies, straight out of the U.S. Treasury. The fact that they have now been taken over means very little, except that a new crop of mis-managers will take over operations at somewhat lower compensation rates.

According to a plethora of financial market pundits, the takeover will "calm financial markets" and hasten the day when real estate values can be determined with some amount of certainty. As long as prices keep falling, sales will not keep up with inventory. Undoubtedly true. However, perhaps the time has come when America really is bankrupt in deed, if not in name, and it will just take a few respected leaders (possibly a presidential candidate or two) to call out the naked emperor. In the meantime, we can expect to be treated to a series of "light at the end of the tunnel" statements by the "powers that be", all designed to calm the savage consumer beast and keep the big money in America instead of some other, more financially stable, country.

Although the real estate fiasco can be hard to understand, a brilliant article in the Sunday, September 14^th San Francisco Chronicle pulls it together about as well as anybody can. The most important point in the article is that the new housing recovery law will likely only benefit the most irresponsible of the impacted homeowners -- this because of the abililty of the lenders to pick and choose which loans they will cash out at 90% of the home's current appraised value. While this approach may help the bottom lines of the various banks that got caught shorthanded, it does little for our sense of fairness. Or, to put it another way, it makes the old saw "let no good deed go unpunished" a little less funny in the case of the millions of homeowners who have struggled to stay current on their mortgages but who will now be deprived of relief because their loans aren't bad enough to justify the lender taking a hit.

An article titled "Lose Homes, Pay More Tax" by Jonathan Glater, published in the May 30, 2008 edition of the New York Times, accurately described a little-known oddity of our tax laws (described in the article as a "tax bomb"). If a lender forgives or writes off debt (same thing), the amount forgiven can be treated as taxable income by the IRS. So, for instance, if you have a second home (not your primary residence) and you lose it to foreclosure or even a short sale, you will be taxed on the shortfall to the lender. Fortunately, loans made to acquire or improve primary residences are excluded from this rule for tax years 2007 through 2009.

What the Times article left out -- strangely, seeing as so many bankruptcy lawyers were quoted -- is that there are two exceptions to the tax bomb. If you are insolvent at the time of the debt forgiveness, you will also be forgiven your tax liability. And, here's the kicker: If you file bankruptcy prior to the debt forgiveness (read: foreclosure) the bankruptcy will not only hold off the foreclosure (at least temporarily), but also discharge the debt, so there's nothing to forgive and no income to tax.

Insolvency can be difficult to prove after the fact, but there is no doubt about the bankruptcy exception. Although many people shy away from bankruptcy, it can be a marvelous remedy when dealing with the possibility of foreclosure. It's beyond my comprehension why that point wasn't made.

If you have old, unpaid debts, you may be safe from a lawsuit to collect the debt, because a creditor or debt collector has a limited number of years to sue you for the debt. To get a better understanding of time limits for debt collection, check out this newly published article in the Nolopedia, "Time-Barred Debts: When Collectors Cannot Sue You For Unpaid Debts".

And if you want further information on debt collection & credit, you might also be interested in my previous post, "When Credit Bureaus Report Debts Discharged in Bankruptcy: It Should Be a Crime".