Managing Car Loans During Bankruptcy: Key Tips
With high mortgage interest rates and household credit card debt at record levels, car loan defaults are also rising. How does bankruptcy affect your car loan? Whether it’s filing for Chapter 7 bankruptcy or Chapter 13, let’s look into this issue to determine the best steps for you financially.
Updated December 17, 2024.
Key Points:
- Mortgage interest rates are over seven percent.
- Credit card debt is more than $1 trillion.
- Car loan defaults are rising.
- Bankruptcy filings continue to increase for Chapter 7 and Chapter 13.
Key Statistics on Consumer Debt
According to the Federal Reserve Bank of New York’s Center for Microeconomic Data, there has been an increase in household debt in the final quarter of 2023.
Mortgage balances increased by $112 billion, for a total of $12.25 trillion. Home equity lines of credit, known as HELOC loans, increased by $11 billion for seven straight quarters dating back to the first quarter of 2022. This amounts to $360 billion.
Auto loans stand at $1.61 trillion, and defaults exceed seven percent.
How Did We Get Here?
Interest rates have increased post-COVID to control inflation. This means the higher the interest rate, the more it costs to borrow money, so monthly payments are higher.
For example, interest rates were at historic lows during the coronavirus pandemic. What happened next? This created a buying frenzy with homes. The more people want to buy homes, the more the prices increase.
Other people refinanced their mortgages, saving them hundreds of dollars monthly in interest payments. However, let’s suppose that a couple is getting divorced today.
If, due to divorce, one spouse wants to keep the house and buy out the other spouse’s equity interest, their mortgage payments will be much higher because of the higher interest rate. So now it’s become common for couples getting divorced that the home must be sold.
With auto loans, we see the same issue: post-pandemic, buying a car has become more expensive. This, besides the fact that the sale prices on new vehicles seemed to border on the ridiculous.
For example, I dropped off my F-250 for service at the Ford dealership last month. Here’s my question: When did it become normal for trucks to cost up to $100,000? But we are seeing this across the board with all makes and models. So not only are cars more expensive, but so is the loan.
But if you have defaulted on your car loan, what options do you have?
Negotiating with the Lender
It has been my experience that after the mortgage crisis of 2008, lenders learned their lesson and have become more flexible with borrowers. If a borrower faces financial difficulty, the lender may defer payments for two to three months.
This can be a financial lifesaver for someone whose income has decreased or is in a separation or divorce stage and whose household income has decreased. So, there’s no harm in contacting the lender and seeing if that option is on the table. A two or three month break from monthly payments on a car loan could be all you need to bounce back financially.
Refinancing Debt
Refinancing a car loan, while risky because it extends the life of the loan, costing you more in the long run, could also help. However, refinancing, whether a mortgage or car loan, requires equity.
The problem with most cars is that the value depreciates substantially during the first few years of the loan, and thus, the car is upside down, meaning more is owed on the loan than the car is worth.
Chapter 7 Bankruptcy and Car Loans
Chapter 7 bankruptcy, known as a liquidation, would generally have no effect on a car loan. The lender is unlikely to reduce payments or stretch out the payments to get a lower monthly payment.
In addition, if you are behind on your car loan unless you intend to surrender the car, which is known as a voluntary repossession, filing for Chapter 7 bankruptcy would not help save your vehicle. Only Chapter 13 bankruptcy could help save your car in that situation.
How Chapter 13 Bankruptcy Can Help with Your Car Loan
Chapter 13 bankruptcy is known as a reorganization. If you qualify for Chapter 13, you could organize your debt and reduce your monthly payments on unsecured debt. This would save you money in the long run.
Chapter 13 bankruptcy will also allow you to keep your car if you’re behind on your monthly payments by stretching out the late payments over the bankruptcy plan, which lasts thirty-six to sixty months.
More importantly, Chapter 13 bankruptcy could also reduce your car payment through “cramdown.”
What is a Chapter 13 Bankruptcy Cramdown?
Chapter 13 bankruptcy offers what is known as a cramdown, which isn’t possible with Chapter 7. A cram down allows you to reduce the balance of your car loan, which could save you money in the long run. The catch is that it doesn’t apply in every situation.
What are the Requirements of a Chapter 13 Cramdown?
Only some people can qualify for a Chapter 13 cramdown on their car loan. Here is what is required:
1. The car was purchased more than 910 days ago.
2. The car loan must be paid off during the bankruptcy plan.
The first requirement is that the car was purchased over 910 days ago. That is done to prevent debtors from buying a car and then turning around and paying off the vehicle within a few years through Chapter 13 bankruptcy.
Regardless of the 910-day requirement, can the debtor afford to pay off the entire balance during the bankruptcy plan? If the balance cannot be paid in full, then the Chapter 13 cram down will not work.
However, remember that unsecured debt, such as credit cards in a Chapter 13 bankruptcy, will receive minimum payments. So even if you can’t afford to pay back the total balance due on your car loan now, you might through Chapter 13 bankruptcy. You can learn more about the cramdown via this link.
Throughout my bankruptcy law textbook, I used the term “number crunching.” Chapter 13 bankruptcy is all about number crunching and lawyers finding creative ways to pay back the debt within three to five years.
So before you conclude that you cannot afford to cram down your vehicle, meet with the Chapter 13 bankruptcy lawyer and have the lawyer number crunch for you after knowing the total amount of your income, expenses, and overall debt payments.
Colleges and universities can purchase my bankruptcy law textbook directly from Routledge Publishing. For paralegals and students buying single copies, you can do so via Amazon books. To access my YouTube channel, click this link.
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Please note the information on this site does not constitute legal advice and should be considered for informational purposes only.
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