Redeeming v. Reaffirming Debt to Keep Property in Bankruptcy

Learn the differences between redeeming property and reaffirming debt in Chapter 7 bankruptcy.

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.

Reaffirming Secured Debts

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.

Redeeming Personal Property

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:

  • serves as collateral for a secured debt
  • is tangible (you can touch it) and is personal property (no real estate)
  • the Chapter 7 trustee abandons it
  • the property debt is consumer, not business debt, and
  • you can pay its current value in a lump sum payment.

You'll find the redemption statute in section 722 of the bankruptcy code. Or read more about keeping a car in Chapter 7 bankruptcy.

Why Redeem Property?

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.

Advantages and Disadvantages of Redemption

Here are a few things you'll want to consider.

Advantages

  • You only pay the value of your property, regardless of how much you owe.
  • The creditor can't object if you're paying the value of the property.
  • While you must pay the creditor in a lump sum, a redemption loan lender will allow you to make payments.

Disadvantages

  • You can only redeem tangible personal property.
  • You can't use redemption to keep real estate or business property.
  • You must be able to exempt the property, or the trustee must abandon it.
  • You must pay the replacement value in one lump sum unless you get a redemption loan—and redemption loans come with high-interest rates.

When Should I Redeem Property?

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.

Redemption Requirements

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:

  • The debt on the property must be a consumer debt, which means it was used primarily for personal, family, or household use. Business property doesn't qualify.
  • The property must be tangible property, which means you can touch it. So you can redeem secured property such as automobiles, appliances, and furniture, but not an intellectual property like interest in a copyright, security investment, or patent.
  • The property must be personal property, not real estate (real property). So you can't redeem land or your home. (Find out about reducing a rental property mortgage and other loan cramdowns in Chapter 13.)
  • You must be able to pay the replacement value of the property in a single lump sum to the creditor within 30 days of the first 341(a) Meeting of Creditors. If you can't agree on the replacement value with the creditor, the court can hold a valuation hearing to determine the replacement value. Although the creditor is not required to accept anything other than a lump sum, several financial institutions are specializing in redemption loans and financing.
  • The property is exempt under your jurisdiction's bankruptcy exemptions, or the bankruptcy trustee has abandoned the property. The trustee will abandon secured property when its equity minus the exemption is less than the fair market value. In practice, the trustee will abandon property worth less than the debtor owes on it, which is what happens in virtually every redemption case.

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