If your car lender repossesses your car, truck, van, motorcycle or other vehicle, you may not be off the hook financially. If your car was underwater (you owed more than it was worth) you’ll likely still owe money to the lender, called a deficiency. And if your car or other motor vehicle has not yet been repossessed, but you are struggling to make payments, you should understand what a deficiency is and figure out if you’ll owe one before you stop making payments.
Read on to learn what a deficiency judgment is, when you’ll owe one after car repossession and your options to avoid a deficiency or get rid of one.
If you took out a loan when you purchased your car, you likely pledged the car as security for your loan. Put another way, your car company has a lien on your vehicle. This means that if you default, the lien allows your lender to sell your vehicle to satisfy any amounts owed on the loan.
The actual process of taking your car from you is called repossession. In most states, a lender doesn’t need to file a court action to repossess your car. Rather, as you may have seen on TV, a lender employs a tow truck driver to physically remove the car from your premises. Unlike what is often demonstrated on popular TV shows, however, in repossessing your vehicle, the repossession agent or tow truck driver cannot breach the peace, break and enter your garage or home, or use violence in taking possession of your car. (Learn more about car repossession.)
After your car is taken, the loan company will sell it. You are legally entitled to notice telling you the date, location, and other details about the sale. The exact procedure varies by state. What happens after that depends on the value of your car and your loan amount.
Your car may be worth more than what you owe on the loan. This is what is known as having equity in the car. If your car sells for more than what you owe, you won’t have to pay the lender any more money and will get funds back from the excess amounts the car sold for. Those funds are often referred to as a surplus.
For example, if your car sells for $10,000, but you owe $7,000, you will receive the $3,000 surplus, minus any of the lender’s expenses incurred in repossessing and selling your car (these expenses can cost you a bundle).
Of course, if your car has equity and you can't make the payments, it's always a better option to sell it yourself, pay off the lender, and keep the excess proceeds. This also will preserve your credit.
Your car may be worth less than what you owe on the loan. This is commonly called being underwater or having negative equity. Many higher interest, long-term car loans lead to negative equity, as your car’s value is depreciating faster than you are paying off the loan balance.
In this situation, the lender will still sell your car, but there will be a difference between what it sells for, and what you owe. This is called the deficiency. If your car sells for $2,000 but you owe $10,000, the deficiency, which you now owe personally, is $8,000. In many states, the lender will have to sue you in court in order to have the deficiency judgment entered against you.
Because of the risk of owing a deficiency, it is always a good idea to do some research before surrendering your car to the lender. You can get a general idea of your car’s value through websites such as Edmunds (www.edmunds.com) or The Kelley Blue Book (www.kbb.com), or by having a dealer appraise it. If that appraisal is less than what you owe the lender, there’s a good chance that you will owe money to the lender in the form of a deficiency after the car is sold. If you have been thinking about stopping payments, you may want to reconsider.
In order to obtain a deficiency, the lender must sell your vehicle in a “commercially reasonable manner.” This varies state by state but generally means that the car must be advertised, and sold publicly, for an amount that’s at or close to the car’s market value.
A lender also may not keep personal property which is inside the car, save for stereos, or other items that are affixed to the car. If your personal property has value and is not returned to you, you may have a claim to offset the amount you owe for the deficiency.
A deficiency judgment is like any other monetary judgment against you. Once it has the judgment, the lender can garnish your wages, attach your bank account, or use other collection measures depending on your state laws, to try to collect the money.
You can try to work out a payment plan with your lender to try to pay the deficiency off. You may also choose to do nothing, and allow the lender to garnish your wages. Federal and state law limits the amount that a creditor can garnish from your paycheck, so if you are a low-wage earner, all, or most, of your income might be protected. (To learn more, see What Is Wage Garnishment?). Alternatively, a car deficiency can be completely eliminated in a Chapter 7 bankruptcy.