What happens to cars in bankruptcy? Or cars with notes? After all, almost everyone filing bankruptcy has a car. And cars are usually one of the larger assets a debtor owns. The answer depends on what a car is worth, whether it’s been paid off, and whether the car lender requires a Reaffirmation Agreement. November 20, 2024
Owned Cars in Bankruptcy (Cars that are Paid Off)
Technically, cars in bankruptcy that are paid off become assets of the Bankruptcy Estate and, as such can be sold by the Bankruptcy Trustee and the proceeds used to repay the debtors’ creditors. But Trustees cannot sell cars worth $7,500 or less (as valued by the Kelly Blue Book Private Party estimates). That’s because the State of California realizes most of us need a car to get to work and otherwise function. But Bankruptcy Law also doesn’t want someone filing bankruptcy to be able to keep a new or valuable car – thus the $7,500 limit on the value of a car that someone filling bankruptcy can keep.
A car worth more than $7,500 can also be kept by the person filing chapter 7 bankruptcy if they claim the car’s value under the Wildcard Exemption. California Bankruptcy law allows everyone going through chapter 7 BK to claim one of two exemptions: the Wildcard Exemption, worth up to $32,000 in the value of any assets the debtor chooses, or the “Homestead” exemption, worth approximately $750,000 in equity in a primary residence/house.
If a debtor owns a car worth more $7,500 and takes the Homestead Exemption, it’s impossible to predict what a Bankruptcy Trustee will do with the equity in a car above $7,500, because it’s up to the individual Trustee. Most Trustees will ignore cars worth up to about $10,000-$12,000 and let the debtor keep it; I even had one Trustee let a client keep a $35,000 Dodge Viper.
What? Why Don’t Trustees Immediately Sell Cars Worth More Than $7,500?
Because it’s an enormous administrative hassle for a Trustee to sell a car: it takes time, administrative follow-through (finding and monitoring an auctioneer to sell the car), and sometimes even a lawyer to seize the car legally. Implication? The costs of seizing and selling a car means that most Trustees don’t take cars in bankruptcy that aren’t worth significantly more than $7,500. That’s the reason I tell clients any car they own worth $10,000 or less is safe (the Bankruptcy Trustee will allow them to keep it).
However, some Trustees either do take the car, or otherwise extract value for creditors. Often, a Trustee demands the debtor pay the difference between the $7,500 vehicle exemption and the actual value of the car, in exchange for allowing the debtor to keep their car after the bankruptcy is concluded. How can someone so broke they’re filing for bankruptcy come up with the funds?
Most of my clients have a friend or relative lend or give them the money. The less common method for the Trustee to take the car is to literally demand title be signed over to the Trustee who then hires an automobile auction company to sell the vehicle.
Leased Cars in Bankruptcy
Counterintuitively, it can be easier to keep leased cars in bankruptcy, than the same car that’s paid off. It all depends on the amount of equity in the car, but people leasing their car rarely have more than $7,500 equity in the vehicle. Consider the example of a recent model Mercedes-Benz GLA230. I had a bankruptcy client who leased this car and thus he had virtually no equity in it. He was able to keep the car because he didn’t legally own the car – Mercedes did.
If he had owned that car, then it would have been an asset transferred to the Trustee in bankruptcy (keep in mind that, in bankruptcy, legal ownership of everything the debtor owes and owns is transferred to the Trustee while the bankruptcy process is and until it is legally concluded when the assets the debtor are entitled to are returned and their debts erased). In the case of this GLA230, the Trustee likely would have sold it, giving my client the $7,500 he was entitled to have in the value of a car, and the Trustee would have used the remainder of the proceeds (after administrative costs) to repay the debtor’s creditors.
Pre-Bankruptcy Planning to Stop Car Seizures by Trustee
While losing the GLA in the bankruptcy is arguably unfair, the more relevant issue this hypothetical example raises is the importance of pre-bankruptcy planning to minimize asset loss for a client. For example, I would have advised a client who owned a $50,000 car that was vulnerable to seizure by a Trustee, and recommended the client sell the vehicle themselves and pay off their most important creditors.
For example, if the client owed recent taxes, I would advise them to pay off the IRS with the proceeds, since only tax debt three years or older can be discharged in bankruptcy. However, this hypothetical client would also need to wait 90 days from the time of selling the Mercedes to file bankruptcy, otherwise the Trustee can legally demand that $50,000 back from the debtor and/or the IRS (debtors aren’t allowed to make payments of more than $600 to any creditor in the 90 days prior to filing bankruptcy without violating the “preference” rule – whereby the debtor is “preferring” some creditors with repayment to others).
Cars with Car Loans: the Case of Lenders
What about the case of a Hyundai Ionic 5 worth $50,000 that a debtor still owes $30,000 on? First, if the debtor doesn’t own his home, then he will use the Wildcard exemption to keep the $20,000 in car equity that he owns. Second, the lender will receive notice of the debtor’s bankruptcy as soon as he files. But the lender is legally obligated to keep the car note in force so long as the debtor continues to make timely, complete and uninterrupted payments. Again, by law a lender cannot cancel a car loan simply because someone has filed bankruptcy.
But many car note lenders will treat a customer in bankruptcy differently once the bankruptcy is filed. In my experience, each lender/bank is different in how they treat a customer in bankruptcy who still owes on their car note. But here are some common practices I’ve seen.
Stopping On-Line Access to Car Loan Account
First, many banks will stop client access to their on-line accounts, including on-line payment of their car loan. But, many banks will maintain on-line access, too, unless there’s a missed payment. Second, rather than accepting on-line payments, the banks shutting down on-line account access typically require a monthly check to be mailed to them for payment. In order to know what to pay, some people will need to call the bank for the exact amount of the payment (since they can no longer look this up on-line). Third, many banks ask for the client to sign a Reaffirmation Agreement, where the client confirms they owe the bank money and commit to continued repayment. However, I do NOT recommend signing a car lender’s Reaffirmation Agreement! Why?
First, the car lender/bank cannot close your car loan account for failure to file a Reaffirmation Agreement. So you cannot be penalized for failing to sign. Second, there’s a strong possibility you’ll be worse off if you DO sign the Reaffirmation Agreement. How?
It has to do with a little legal fiction/slight-of-hand: prior to filing bankruptcy, BOTH the debtor and the car owed the money, meaning the car lender/bank can go after both the debtor for what’s owed (by suing) and the car (by repossessing it). The bankruptcy erases the debt from the debtor, but not from the car, leaving only the car owing the money (I said this would involve legal “fiction”!). What a Reaffirmation Agreement does is put the individual back on the hook for what’s owed. Why do this? The car lender/bank can’t force you to. If you don’t make your payments, the bank still has the right to repossess your car. Why also give them the right to sue you personally? In short, don’t sign a Reaffirmation Agreement.
Got Questions about Cars in Bankruptcy? Got Questions about the Bankruptcy process in general? Call me – my team and I love educating people on how bankruptcy works and how it would work with your specific debts and assets.
November 20, 2024