Everyone would like to sail through bankruptcy without any problems—but that might not happen if you file a Chapter 7 bankruptcy soon after buying an expensive car. Read on to learn how a luxury purchase can jeopardize your bankruptcy case.
People who don’t have enough income to pay something to unsecured creditors (like credit cards and medical bills) are well suited for this chapter. You’ll qualify if, after comparing your income and expenses, you don’t have enough left over (disposable income) to make a meaningful payment in a Chapter 13 bankruptcy. In that case, you’ll have passed the “means test.”
Ordinarily, a car payment will help you pass the means test by lowering your disposable income. The standard vehicle ownership deduction is $517 per month (as of August 2017). However, you can use your actual payment if it’s higher than the standard deduction and the amount is reasonable and necessary.
Here’s the catch: The court will question the necessity of your payment if it strays too far from the norm, and possibly reduce your allowable expense to something more reasonable. If you needed the higher amount to pass the means test, losing it could preclude you from a Chapter 7 filing.
Filing a Chapter 7 case on the heels of an expensive car purchase can elicit an objection from the bankruptcy trustee, the official responsible for managing your case. The court will decide the reasonableness of the dispute by analyzing the following:
Example. Julia bought a $40,000 car three months before filing for Chapter 7 bankruptcy and claimed the $850 monthly expense on the means test. The trustee objected, however, stating that $550 per month would be more reasonable, thereby leaving $300 per month to repay creditors. The bankruptcy judge agreed and converted Julia’s case to a Chapter 13 bankruptcy.
The trustee could go even further and allege that the bankruptcy was filed in bad faith (the filer tried to take advantage of the system). When deciding the bad faith dispute, the court will consider the honesty of the filer by evaluating:
If the trustee or a creditor can prove bad faith, the court could dismiss the case, or deny the discharge and take the filer’s nonexempt (unprotected) property.
(To learn more, see What Property Is Exempt in Bankruptcy?)
A large car payment can also affect whether you can keep the vehicle and continue making payments after your qualifying debts get wiped out (discharged) in a Chapter 7 case. Ordinarily, you would need to enter into a reaffirmation agreement (a new contract) that will survive the bankruptcy. You’ll make the reaffirmation agreement payments after the bankruptcy. If you fail to do so, the lender will be able to repossess the car. You’ll be responsible for any deficiency (the difference between your balance and the auction proceeds).
Here’s the potential problem: You can only reaffirm the loan if you can afford the payment. You must prove that, after your expenses, you have enough left over to cover the debt. If the reaffirmation shows that you can’t afford the payment and your attorney is unwilling to sign the agreement certifying that you have the ability to pay, the court will schedule a hearing so that the judge can question you directly to determine if the reaffirmation is necessary.