Car Loans in Bankruptcy: How to Reduce Payments

If you have a car loan that's causing your trouble and you need to file bankruptcy anyway, you may be able to reduce your car loan in bankruptcy.

Basics of Car Loans

Car loans are secured loans. This means that the car itself is security, or collateral, for the loan--fail to pay, and the lender can take your car. Another characteristic of car loans is that because of how fast cars depreciate, the remaining balance on the loan is almost always more than the car is worth.

Secured Loans in Bankruptcy

Because of the security interest, secured loans act differently than unsecured loans (e.g. credit card debt, medical bills) in bankruptcy: the lender has the right to repossess if not paid. This means that the debtor can't entirely escape the secured loan, not if he or she wants to keep the property. However, remember that the car is almost certainly worth less than the loan--that fact gives you leverage.

Chapter 7 Bankruptcy

There are two common kinds of bankruptcy for individuals. In Chapter 7, the debtor's assets--his or her belongings and property--are "liquidated" for the benefit of creditors. For a secured debt, the debtor must "affirm" the debt, or agree to keep paying it; otherwise, the creditor gets the property and the remaining debt will be wiped out. Of course, the creditor doesn't want your car; it wants to be paid as much as possible. You can use the leverage you get under bankruptcy to negotiate with the creditor. If the creditor will agree to take less than the full amount remaining on the loan, you can affirm the car loan for less while still keeping the car. Given how much cars depreciate, it's in the creditor's interest to work something out with you.

Chapter 13 Bankruptcy

In Chapter 13, a payment plan is developed, under which the debtor will pay creditors as much as possible over time. There is a mechanism called a "cram down" under which the court can force most secured creditors to accept an amount equal to the then-current value of the property instead of the full amount owed under the loan. Again, since cars depreciate quickly, this can result in keeping your car while paying less. Generally, you need to have owned your car for 2 1/2 years before doing this.

How an Attorney Can Help

An attorney can help a debtor decide which form of bankruptcy is better for him or her, and handle all the often-complex paperwork requirements while taking advantage of all the rules, like property exemptions or cram down, which are there for debtors' protection.