The Motor Vehicle Exemption in Chapter 7 Bankruptcy

The motor vehicle exemption helps Chapter 7 bankruptcy filers protect cars from creditors. But the motor vehicle exemption is one piece of the puzzle. Whether you can keep a vehicle in Chapter 7 bankruptcy depends on how much the car is worth, how much you owe, and how much equity you can protect using the motor vehicle exemption.

Keeping a Car in Chapter 7 Using Bankruptcy Exemptions

Chapter 7 filers erase debts in a matter of months without repaying creditors. In exchange, they can only keep the property they need to work and maintain a home. The Chapter 7 trustee responsible for administering the case sells everything else for the benefit of creditors.

You'll know whether you'll lose property in bankruptcy and which assets you can keep by reviewing "bankruptcy exemptions," the laws that set forth what bankruptcy filers are entitled to protect from creditors. You'll want to pay specific attention to motor vehicle and wildcard exemptions—they're the exemptions used to protect cars, trucks, motorcycles, and more.

Motor Vehicle Exemptions

A "motor vehicle exemption" specifically protects vehicle equity. In most instances, you'll use your state's motor vehicle exemption. However, some states allow filers to use the federal bankruptcy exemptions instead. If you can choose between the two sets, you'll want to evaluate how well each set will protect all of your property because you must stick with one exemption set. You can't pick and choose exemptions from both.

Wildcard Exemptions

If the motor vehicle exemption isn't enough to completely protect your car's equity, you might be able to cover the gap with a wildcard exemption. A wildcard exemption is much broader and allows the filer to decide which asset to protect. The federal exemptions include a substantial wildcard exemption, but not all states offer one.

If you use a state wildcard exemption, check for conditions. For instance, ensure that you can stack it on the motor vehicle exemption (most states allow it) and that using it on a motor vehicle isn't prohibited (it would be unusual, but it's best to check).

How to Calculate a Motor Vehicle Exemption in Chapter 7

Once you know the motor vehicle and wildcard exemption amounts, you'll determine whether you can fully protect the vehicle equity. Your calculation will differ slightly depending on whether you own your car outright or are paying a vehicle loan.

Calculating a Motor Vehicle Exemption Without a Car Loan

Your equity is the car's value if you aren't paying a vehicle loan. To prevent the trustee from selling the car, you must exempt an amount equal to the car's value.

Of course, before selling the vehicle, the trustee will determine whether selling the car will net enough funds for creditors to be worth the effort. A reasonable amount must remain after giving you the exemption amount and subtracting sales costs and the trustee's fee.

If a sale wouldn't bring much for creditors, the trustee will "abandon" the car, and you'd get to keep it. Keep in mind that this information is for your knowledge only. You can't subtract sales costs when listing your vehicle—or any property—in bankruptcy schedules. The determination is made solely by the trustee.

Example. Assume your car is worth $3,000, and your state's motor vehicle exemption allows you to exempt up to $4,500 in motor vehicle equity. In this case, your car would be wholly exempt. The trustee wouldn't sell the vehicle. You'd keep it.

Example. Assume your car is worth $5,000 and your state's motor vehicle exemption is $4,500, leaving only $500 in nonexempt equity. The trustee would likely abandon the car because little would remain after deducting sales costs and the trustee's fee. You'd keep the vehicle.

Example. Assume your car is worth $10,000 and your state's motor vehicle exemption is $4,500, leaving $5,500 in nonexempt equity. The trustee will sell the car, give you $4,500 for the motor vehicle exemption, deduct sales costs and the trustee's fee, and distribute the balance to creditors. You'd lose the vehicle.

Calculating a Motor Vehicle Exemption With a Car Loan

If you're still paying for your car, determining how much equity you must protect requires an additional step. The equity is the amount you could put in your pocket if you sold the car and paid off the loan. So, subtract the car loan amount from the car's value. The amount that remains is the equity amount you must protect with exemptions.

Example. Assume your car is worth $10,000, and you owe $8,000 on the car loan. Your equity would be $2,000 ($10,000 value - $8,000 car loan = $2,000 equity). The equity would be wholly exempt if the motor vehicle exemption were $4,500. You would keep the car.

Example. Assume your car is worth $10,000, and you owe $12,000. In this situation, you wouldn't need an exemption because your vehicle would have no equity ($10,000 value - $12,000 loan = - $2,000 or zero equity). You would keep the car.

Example. Assume your car is worth $25,000, you owe $10,000, and the motor vehicle exemption is $4,500. Your equity would be $10,500 ($25,000 value - $10,000 loan amount - $4,500 exemption = $10,500 nonexempt equity). The trustee would sell the car, pay you $4,500 for the exemption, pay the vehicle lender $10,000, subtract sales costs and the trustee's fee, and distribute the remaining amount to creditors.

Additional Requirements for Financed Vehicles

Covering equity with bankruptcy exemptions will protect a vehicle from the Chapter 7 trustee. However, if you want to keep a financed vehicle in Chapter 7 bankruptcy, you must also take steps to protect it from the lender.

Because of the lender's lien rights, you must continue to make monthly payments as agreed. Otherwise, the lender can ask the bankruptcy court to allow the lender to repossess the car. The bankruptcy court will approve the lender's motion unless the filer brings the loan current or enough vehicle equity exists to protect the lender's interests (in which case, nonexempt equity would likely exist, and the trustee would want to sell it for the benefit of creditors).

Because the only viable way for a filer to keep a financed vehicle is by protecting all vehicle equity with bankruptcy exemptions and maintaining current loan status, most bankruptcy lawyers recommend making sure the car loan is current before filing the Chapter 7 case. The reasoning behind the approach is simple.

Most bankrupt people wouldn't be able to bring a loan current weeks after filing for Chapter 7. If they could pay, it would be better to do so before filing and avoid an unnecessary motion—even if it meant delaying the filing by a few weeks (this assumes more pressing issues don't exist).

Learn more about keeping cars in bankruptcy.