Can You Reduce Your Car Loan in Bankruptcy?

In certain situations, you can reduce the principal amount owed on your car loan in Chapter 7 or Chapter 13 bankruptcy. The method for doing so differs between these two chapters of bankruptcy. Here's how these options work. 

Cram Down the Car Loan in Chapter 13 Bankruptcy

In Chapter 13 bankruptcy, you might be able to reduce the principal balance owed on a car loan that is no longer fully secured by the car. A car loan is not fully secured if the value of the car is less than the remaining amount of your loan. Because the value of automobiles depreciate so quickly, this is a common situation. 

Here's an example of a car loan that is not fully secured. You owe $5,000 on your car loan, but your car is now worth only $3,000. Only $3,000 of the loan is secured by the value of your car.

If your car loan is not fully secured, you can "cram down" the principal balance of the loan to the replacement value of the car. The replacement value is the amount a retail merchant would charge for your car, given its age and current condition. You must pay off this new balance by the end of your Chapter 13 bankruptcy (three to five years). The remainder of the loan (the part that is unsecured), is reclassified as unsecured debt and added to your other unsecured debts. You pay unsecured debt through your bankruptcy repayment plan -- usually at a discount. 

So, in the example above, you could reduce your car loan to $3,000. You would pay this off in full by the end of the bankruptcy repayment plan period. The remaning $2,000 would be added to your other unsecured debts. You would probably pay only a portion of this through your plan. 

In order to qualify for a cramdown, you must have purchased the car  at least 2 ½ years before filing for bankruptcy. For more details on how cramdowns work see How a Cram Down Works in a Chapter 13 Bankruptcy Case.

Reducing Your Car Loan in Chapter 7 Bankruptcy

In Chapter 7, you can take advantage of your right to "redeem" your car loan. You might consider this if you are going to lose your car because you are behind in your payments. When you redeem the car, you pay an amount equal to the replacement value of the car. In many cases, the replacement value is much lower than your outstanding loan balance. 

The catch: You have to redeem the car with one lump sum. Few bankruptcy filers have the cash to do this. 

To get the details, see Redeeming Property in Chapter 7 Bankruptcy.)

Other Options

To learn about other options for car loans in bankruptcy, see Will Filing for Bankruptcy Get Back a Repossessed Vehicle?

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