Chapter 13 Bankruptcy and Car Loans in Arizona
When it comes to choosing what kind of bankruptcy to file, I find that Chapter 13 bankruptcy is often a better tool than Chapter 7 for dealing debt to keep your car in bankruptcy.
Buying a Car is Big Purchase
Next to houses, cars are normally your biggest purchase. Right now, the average cost of a new car or truck sold in Arizona is about $34,000. These days financing is often extended to seven years or so. Once interest is factored in, you can easily find yourself ultimately on the hook for over $43,000.
Cars Lose Value Fast in Phoenix
Problem is that in contrast to houses, the car is losing value as soon as you drive it off the lot. The depreciation issue means that a couple to three years after you bought it, the brand new car that was a dream when you bought it for $34,000 is now a real loser. Now you owe, say, $28,000 on an $18,000 car and it’s just going to get worse and worse. And outside of bankruptcy, there’s no way out.
Chapter 13 Can Solve Car Loan Problems in Phoenix
Bankruptcy does offer a number of options to address this upside down car issue. Which chapter you choose often depends on whether you want to keep your car in bankruptcy.
If you are going to just walk away from your car loan, both Chapter 7 and Chapter 13 are both great. In Chapter 7 bankruptcy, the balance on your car loan is generally discharged along with all your other unsecured non-priority debt. In Chapter 13, your car lender can file a claim for the deficiency on the car loan which will just be added to the list of unsecured creditors and will likely be paid pennies on the dollar if that. But what if you want to keep the car?
Keeping Your Car with Chapter 7
If you want to keep the car in Chapter 7 bankruptcy, you can either try to just keep making payments, sign off on a reaffirmation agreement that reaffirms your obligation to keep making payments, or, if you qualify, redeem it. If you keep the car and don’t sign a reaffirmation agreement, you have limited your risk. The best the lender can ever do is repo your car if you stop making payments.
The downside of not reaffirming is that the creditor will probably repo your car quickly if you are ever late. Also, the creditor probably will probably not report your payments to the credit reporting agencies. So you end up paying off a car without getting any “credit” for it.
If you want to keep the car in Chapter 7 bankruptcy and opt to sign off on a reaffirmation agreement. You get credit for making the payments on your credit score and your lender is a little more likely to stay on the sidelines if you are late. The downside is terrible though.
If you ever get sick or miss work and the car does get repo’d, your lender is going to sue you for a big back balance and you will not have the protection of the Arizona Bankruptcy Court. Even worse, you are getting out of bankruptcy and signing off on a car that isn’t worth what you owe on it. Do you really want your financial life off by signing off on a car loan for an upside-down car?
Redeeming You Car to Keep It
One other option that you have for car loans is redemption. Strictly speaking, you are entitled to redeem your car. This means that you make a lump sum payment for the value of the vehicle to your lender. Let’s say your car is worth $10,000 and you owe $20,000. If you have $10,000 lying around, you get the car and get out of the negative equity. Problem is most people can’t get their hands on the $10,000. There are lenders that specialize in redemption loans but they have house rules for which cars will qualify. Probably worth looking at though.
Chapter 13 May Be the Best Way to Keep Your Car
Generally, I like Chapter 13 bankruptcy for big car loans. No reaffirmation agreement. If you miss work and end up a month behind on your car loan, the lender has to file a motion and set it for a hearing which gives us a chance to work out repayment options before your lender comes close to laying a finger on your car.
Often we can improve your car loan in Chapter 13. If the car loan was originated over 910 days before filing or was refinanced any time after purchase, a Chapter 13 allows you to reduce the amount you owe on a car to the value of your vehicle. The savings here can be massive. If your loan was $20,000 and the fair market value of your car is $14,000 we are reducing your car loan by $6000 and all of a sudden the car loan isn’t upside down anymore. You can’t do this in Chapter 7 bankruptcy.
Any car with a bad interest rate can be reduced to about six percent. May not sound like much to you now, but if you sit with a debt calculator and look at how much you will save by reducing a 25,000 car loan with a 20% interest rate to 6%, you will be amazed at the savings.
If your current car loan is a trade- in with negative equity from the trade-in transaction, we can usually strip all the negative equity out of your car loan, reducing the balance that actually has to be paid back.
What I love most though is that you can now treat your car loan as a lease. Sure it makes sense to make payments on this car (probably with a reduced principal and interest rate) for the next year or so, but it’s just going to keep depreciating. Maybe two years from now, we make the lender take it back and stop making payments on it. Can’t beat that.