Written by Charleston Bankruptcy Lawyer, Russell A. DeMott
There’s a term you hear in the car business all too often: “upside down.” You’re upside down on your car loan when you owe more than the car’s worth. With a procedure available in Chapter 7 bankruptcy called “redemption,” you can use this to your advantage.
Redeeming property is to buy it back. Redemption in bankruptcy allows you to pay the lender the value of the vehicle, rather than what you owe on the vehicle. And there can be a huge difference in those two amounts.
Let’s take an extreme example to illustrate how redemption works. Say you owe $20,000 on a vehicle, but it’s only worth $10,000. How could this be? There are several reasons:
- You bought a vehicle that rapidly depreciated. After all, some brands hold their value; others drop like rocks;
- You drive more than normal. Perhaps you have a long commute to work and put 20,000 or more miles on your vehicle per year;
- You “roll over” negative equity from one vehicle loan into the next when you purchase your vehicle; or
- You have all of this going on–a combination of all the equity destroying factors.
With a redemption, you’d pay a lump sum of $10,000 to the auto lender, and if that’s the value of the vehicle, that’s all you would have to pay to have the lien released.
“Not so fast. How do I get the $10,000?”
That’s a very good question. And it’s a very big problem for most Chapter 7 debtors. Almost no one with financial problems has access to $10,000.
However, there are possible sources of funds:
- You could borrow the money from relatives after you file your case;
- You might be able to borrow against your 401(k) or withdraw money from your IRA;
- Lastly, you can borrow the needed funds from various lenders who specialize in these transactions.
Don’t get me wrong, I’m not a big fan of asking clients to borrow from family. Nor do I like the idea of getting into retirement funds to pay for a car. However, if the savings is significant enough, it may make sense. As with most any question in bankruptcy, the answer is: “it depends.”
The last option, refinancing the vehicle with a new lender is probably the best option most of the time.
“But I just filed bankruptcy. Will anyone loan me money?”
The answer is yes. There are companies specializing in loans for bankruptcy redemptions. Your interest rate may–or may not–be higher. However, you must weigh that against the huge savings you’d get by wiping out $10,000 of what you owe on the vehicle. Paying a bit higher interest on a much lower balance might not be all that bad.
Redemption isn’t right for every Chapter 7 auto loan, but it’s an option which is worth exploring in some cases where there’s a a significant amount of negative equity.
I’ll discuss other options for dealing with auto loans in Chapter 7 bankruptcy in future posts. Among those options are:
- Surrendering the vehicle and purchasing another vehicle (yes, this can be done!);
- Reaffirmation of the auto loan; or
- “Retain and pay” or “ride through.”
On last thing: you may redeem any personal property in Chapter 7, so redemption doesn’t just apply to auto loans. I’ve just used auto loans as an example.