When you put up collateral as security when taking out a loan—such as your car—you agree that the lender can take the property if you don't make payments per the contract. Filing for bankruptcy doesn't change this rule. So if you file for Chapter 7 bankruptcy and want to keep property encumbered by a secured debt (such as a car loan), you typically have to do one of two things: reaffirm the debt or redeem the property.
A bankruptcy discharge wipes out all qualifying debt, including car loans and other secured debt. But it doesn't eliminate a lender's right to take the collateral you agreed to put up to ensure payment of the loan (often a car). As a result, you must continue to make payments on secured debts if you want to retain the collateral.
Because bankruptcy wipes out the loan, some lenders will require you to sign a reaffirmation agreement if you want to keep the property. You sign a new contract with the lender and make yourself personally liable on the obligation again. Most loans reaffirmed in bankruptcy are car loans and the reaffirmation agreement will likely have the same terms as the original loan. However, you can negotiate with the lender to reduce your interest rate or principal balance. When you sign a reaffirmation agreement, the court will usually hold a hearing to decide whether to approve it or not.
If you decide not to reaffirm the debt, many lenders will still allow you to keep the property as long as you continue to make timely loan payments. But some lenders are known to repossess the property unless you reaffirm their debt even if you are current on your payments. Depending on the rules in your jurisdiction, a bankruptcy judge might deny the reaffirmation agreement—some courts don't think signing them are in a debtor's best interests—but order that you can keep the collateral if you remain current on your payments.
Learn more about keeping property by reaffirming secured debt.
Each bankruptcy chapter has particular benefits for a debtor. In Chapter 7, you can buy or "redeem" your secured personal property at a discount by paying its current value, not the amount you owe. This option can save you quite a bit if you owe substantially more than what the property is worth, and the property meets these requirements:
You'll find the redemption statute in section 722 of the bankruptcy code. Or read more about keeping a car in Chapter 7 bankruptcy.
Redemption is often a good choice if your property is worth much less than the loan balance. With redemption, you are potentially saving thousands of dollars by paying only the replacement value of the property, regardless of what you still owe.
For example, if you own a car worth $5,000 but you still owe $10,000, you can redeem the vehicle by paying the creditor $5,000. The car is yours free and clear. The creditor cannot object if you follow the above guidelines and pay the $5,000 in a single lump sum.
Here are a few things you'll want to consider.
Although most filers use redemption to keep automobiles, you can also use it to keep electronics or household appliances you have financed. Since electronics are quick to drop in value, you might want to consider redemption if they are still relatively new.
Another reason to redeem your property is to avoid the difficulty of purchasing new property on credit for a few years after your bankruptcy. If you need the property (for example, a car that gets you to work) and it's in good working condition, consider redeeming it as opposed to letting the creditor take it back and then trying to purchase a similar property after your bankruptcy.
Although redemption is a relatively simple process, it doesn't apply to all property types—and that isn't the only hurdle. You'll need to meet these guidelines to redeem your secured property: