Under certain circumstances, it is possible to remove a consensual lien (a lien you agreed to) from personal property that you are claiming as exempt in bankruptcy. Removing or reducing a lien in bankruptcy is often called lien avoidance. Bankruptcy law allows you to avoid certain consensual liens that impair, or restrict the benefit you receive from, exemptions. But there are some limitations.
A consensual lien is one you agree to. If you pledge your car as security for a loan you take out from the bank, that is consensual. If the IRS or a judgment creditor places a lien on your property, that is not consensual. You can avoid only certain types of consensual liens. To qualify, they must be
Non-possessory liens. A lien is non-possessory if you don’t have to leave the property you pledge as collateral with the lender. Non-possessory liens allow you to keep the collateral while you are paying on the loan. Most liens are non-possessory. An example of the less common possessory lien would be a pawn shop loan. When you borrow money from a pawn shop, you leave the collateral behind and you don’t get it back until you pay off the loan. Possessory liens are only liens while the lender has your property and are not avoidable. Non-possessory liens stay with the property, no matter who is in possession, and can be avoided.
Non-purchase money liens. A lien is non-purchase money if you did not take out the loan to buy the property that is pledged as collateral. This generally means that you owned the property before you borrowed money and pledged the property to secure its repayment. For example, if you paid off your car completely but later took out a loan for another purpose and gave the lender a lien on your car to get the new loan, this would be a non-purchase money lien.
You can avoid a non-possessory, non-purchase money, consensual lien only if:
What you can claim as exempt varies depending on where you are located. There are federal bankruptcy exemptions and each state has its own exemptions. Some states allow you to choose between state and federal, while others require you to use only the state exemptions.
(To learn about exemptions, check out our Bankruptcy Exemption section)
Whether the entire lien can be avoided or only part depends on the value of the collateral, the amount of other liens on that same collateral, and the amount you are allowed to claim as exempt. It can be tricky to figure out how much of the lien can be avoided if you can only claim a portion of the property as exempt, but if you can claim the entire property as exempt, you can avoid the lien entirely.
If you can claim only a portion of the property as exempt, you can calculate the part of the lien that is avoidable by adding together the amount of the exemption, the lien amount and the amount of any other liens on the property (including purchase money liens, and non-consensual liens such as judgment and tax liens) and comparing this amount to the value of the property. If the property is worth more that the total of the exemption amount and the liens, no part of the lien is avoidable. If the property is worth less, the lien is avoidable to the extent of the difference.
John took out a $2,000 personal loan and pledged his piano, worth $3,000 as collateral. He can claim $2,500 as exempt under a wild card exemption. The exemption amount plus the lien totals $4,500. Since the $3,000 value of the property is $1,500 less than this amount, $1,500 of the lien amount can be avoided.
The bankruptcy law limits this type of lien avoidance to the following categories of personal property:
Under the federal exemption scheme, the amount of any lien on animals and crops, or implements, professional books and tools of the trade, that can be avoided is limited to $6,225 as of April 1, 2013. This amount adjusts every three years.
Generally, motor vehicles are included only if you can claim them as exempt as a tool of the trade or a professionally prescribed health aid. This type of lien avoidance is not available for real property, such as your home.
(To learn about other methods of removing or reducing liens on motor vehicles, read Can you reduce your car loan in bankruptcy?, or to learn about removing or reducing liens on real property, see What happens to mortgages in bankruptcy? )
Liens are not avoided automatically in bankruptcy. If you want to avoid consensual liens that impair your exemptions, you will need to file a motion and obtain a court order declaring the liens avoided. If you do nothing, liens will generally pass through the bankruptcy untouched and still be in place after you receive a discharge, even if your personal obligation to pay is discharged. Under those circumstances, if you don’t pay, the creditor can still enforce its lien rights and collect from the property.