A Fresh Start on Your Vehicle Loan through Chapter 7 “Redemption”
Jan. 11, 2016
You may be able to keep your vehicle for less money by “redeeming” it—paying its present fair market value instead of the full debt.
If you owe much more on your vehicle than it is worth and absolutely must keep this vehicle, you may greatly benefit from a fresh start on that vehicle. It may even be worth getting a new loan, one based on what the vehicle is now worth.
If you want to keep your car or truck when filing a Chapter 7 “straight bankruptcy” your main options are “reaffirmation” and “redemption.” We covered reaffirmation—entering into a formal agreement to repay the loan as if you had not filed bankruptcy—in our last blog post. Redemption is not as common but can be a useful option, especially if you owe much more on your vehicle than its present value.
What is Redemption?
Instead of “reaffirming” the vehicle loan by in effect re-promising to pay it in spite of your bankruptcy, with redemption you are getting rid of that loan by paying less—the current fair market value of the vehicle. The challenge is that current value has to be paid to your lender all in one lump sum. We’ll talk about how to get the money for this lump sum pay off shortly.
Here are the steps for you and your attorney to successfully redeem your vehicle:
Determine the appropriate value of the vehicle
Get the vehicle lender to agree to that value or negotiate a value that is reasonable
If the lender and you can’t agree, go to court for a judge to decide the appropriate value
Pay the entire agreed or court-ordered amount within a specified period of time.
Depending on how you get the money to redeem your vehicle, redemption can save you a lot of money. Especially if you owe much more than your vehicle is worth, wiping out the entire balance and paying only what the vehicle is worth may save you thousands of dollars. This benefit is magnified if you have a high-interest loan and so are avoiding paying all that interest over the entire life of the loan.
Once the agreed or court-ordered amount is paid to the lender it must release the lien it has on the vehicle.
Coming up with the Redemption Amount
The challenge of course is coming up with the fair market value of the vehicle, even if it is much less than its loan balance.
First, consider creative ways of coming up with the necessary cash out of your own assets. You generally don’t want to tap retirement money at all, much less to pay for a depreciating asset. But especially if you are old enough that you may avoid paying penalties for accessing an IRA or 401(k), so under certain circumstances doing so may be worthwhile. Generally, be creative and don’t immediately assume you don’t have a way to get ahold of the necessary money.
Second, along the same lines consider asking relatives or friends for gifts or probably more realistically to lend you the money you need for redemption. Explain that this will enable you to keep necessary transportation for much less money. As far as your practical credit-worthiness, you can show your friend or relative that all or most of your other debt are being wiped out through your Chapter 7 case shortly and so you will reliably be able to make payments on a personal loan. The friend or relative can become the lienholder on the vehicle, giving more assurance that you’ll pay the loan.
Third, get a redemption loan from a bank, credit union, or other financing sources which are set up to do this specialized kind of financing. Because there will be little or no equity cushion with this type of loan, you will likely pay a high interest rate. So you and your attorney need to carefully review the terms and calculate whether the decreased loan balance significantly reduces how much you pay overall in spite of what may well be a higher interest rate. Under the right circumstances you may reduce your monthly payment or the payment period, or possibly both.
The Chapter 13 “Cramdown” Option
If you must keep your vehicle and it is worth significantly less than you owe, but you can’t redeem it because you can’t scrape up the fair market value or qualify for a redemption loan, there is one more option. It may be worthwhile to instead file a 3-to-5-year Chapter 13 “adjustment of debts” and re-write your present vehicle loan by forcing your lender to accept lower payments, usually a lower interest rate, and almost always substantially less overall—a “cramdown.” That’s the subject of our next blog post a couple days from now.