Earlier this month we wrote about the three kinds of debts—secured, priority, and general unsecured. Today we get into secured debts, ones in which something you own secures the debt for the creditor. We start with vehicle loans. Specifically, in a Chapter 7 “straight bankruptcy” case whether you should “reaffirm” your vehicle loan in order to keep the vehicle.
The Reaffirmation Agreement
If you have loan on your vehicle, the lender is almost certainly a lienholder on your vehicle’s title. If so, and you are considering bankruptcy and want to keep your vehicle, signing a reaffirmation agreement with the lender in a Chapter 7 case is one of your options.
A reaffirmation agreement is a document, usually prepared by your vehicle lender, which you sign and is then filed at the bankruptcy court. It excludes that loan from the legal write-off—the “discharge”—that bankruptcy gives you for all or most of your debts.
Not Discharging Your Vehicle Loan
All you debts are discharged except special ones that the law does not allow to be discharged, like child support and recent income taxes. If you have any of those special debts you don’t have any choice about whether they will be discharged. But you do have a choice about whether to discharge your vehicle loan.
If choose to stay legally liable on your vehicle loan, that is, you don’t want to discharge that debt, then you do sign a reaffirmation agreement. If you don’t want to stay liable on your vehicle loan, you don’t sign it.
Choosing to Stay Liable on the Vehicle Loan
As you no doubt know, if you owe on your vehicle and you stop making payments on it, the lender has the right to repossess the vehicle. That doesn’t change in bankruptcy. It might just take a little longer. But if your lender is a lienholder on your vehicle’s title, you have to pay the loan to keep the car.
The purpose of the reaffirmation agreement is to make you remain liable on the loan so that you can keep your vehicle.
Your Opportunity to Avoid Liability on the Vehicle Loan
Be sure to recognize that bankruptcy gives you a one-time opportunity to get out of a bad vehicle purchase. It gives you the unique option of undoing the deal. The vehicle may have turned out to be untrustworthy and not a good value. You may not be able to afford its monthly payments and other costs. You may simply owe way more than it’s worth. You have an opportunity to give it back and discharge whatever remaining debt there would be.
This is a very important option you should seriously consider. Most of the time if you surrendered a vehicle you would still owe the creditor thousands of dollars. This is called the deficiency balance—the debt you owe, plus a usually unexpectedly large number of costs tacked on, minus usually an unexpected small credit for the proceeds of your sold vehicle. Bankruptcy allows you to surrender your vehicle and discharging the deficiency balance so that you owe nothing.
The Ride-Through Option (Or Lack of It)
You should be cautious about staying liable on your vehicle loan—by signing a reaffirmation agreement—if you were concerned about the risk that you would not be able to make the payments down the line and so have to surrender it in the future. That’s because then you would likely be left owing a bunch of money—the deficiency balance just described.
If so, you’d rather be allowed to keep the vehicle without reaffirming the loan. This is sometimes called the “ride-through” option. You’d just keep making your monthly payments on the loan, keep the insurance current, and once you paid off the loan you’d receive free and clear title to the vehicle.
With “ride through, if at any point before paying off the loan you could not make the payments, or decided the vehicle was no longer worth keeping, you could just surrender it. And you would owe nothing. You’d owe nothing because the debt on the vehicle loan would have been discharged in the bankruptcy case. That’s because you hadn’t signed a reaffirmation agreement excluding that loan from the discharge.
Usually You’re “Forced” to Sign a Reaffirmation Agreement to Keep the Vehicle
Most of the time you don’t have the “ride-through” option. So you agree to sign a reaffirmation agreement because most vehicle lenders require you to if you want to keep the vehicle.
Lenders require a reaffirmation agreement for good reason. They want you to have the risk of owing a deficiency balance hanging over your head as you make your loan payments. That motivates you to keep making the loan payments through to the end of the contract. They know that the vehicle’s value could well go down faster than the balance. They don’t want to leave you with the option of surrendering the vehicle whenever you want. They don’t want to lose money when you surrender the vehicle at some point and they can’t resell the vehicle for the full remaining balance.
Options Other Than Reaffirmation
So are you stuck with either reaffirming the debt and risking a future deficiency balance, or letting go of the vehicle? Not necessarily.
First, although most vehicle lenders require debtors to sign a reaffirmation to keep a vehicle, some may not. It’s a matter of the lenders’ discretion, and how much they want to keep getting paid instead of having you just surrender the vehicle now, which is the leverage that you have. This is a good reason for you to work with a highly experienced bankruptcy attorney, one who deals day in and day out with all of the national and local vehicle lenders and knows their practices.
Second, reaffirmation agreements apply only to Chapter 7 “straight bankruptcy.” Chapter 13 “adjustment of debts” would likely give you more flexibility, sometimes tremendously much more particularly with vehicle loans. You may even be able to do a “cramdown,” reducing your monthly payment and potentially saving you thousands of dollars on the balance. That will be the topic of the next blog post.