Driven to Bankruptcy in Upside-Down Car

Dear Bankruptcy Adviser,

My husband and I are preparing paperwork to file for a Chapter 7 bankruptcy. One of our major issues is we have two cars, and the loans for both of them are upside down. That is, they are for more than the cars are worth. At present, we plan to reaffirm the car loans on our vehicles even though I would prefer to let them go because they're upside down. Our problem is that we live outside of the metro area where we both work. We need two vehicles. But we have no cash to purchase cars. If we chose to surrender the cars we have now, how could we obtain replacement vehicles?

-- Jennifer

Dear Jennifer, You ask a great question and definitely are thinking about the most important parts of life after bankruptcy. Most families need two cars. And unless the cars are paid in full and reliable, you have to find ways to finance them and make the payments.

You mention that you have considered turning them in prior to filing bankruptcy. This is an option. And since you owe more on the cars than they are worth, it might be a sound one. But you must make sure you are prepared for life without a car (or cars) or have another car available. Here are some of my thoughts.

One, how many car payments do you have left? You say the vehicles are worth less than what you owe. If you have less than two years of payments left, maybe keeping them is the best idea. That's because any new car loan after you have filed bankruptcy will likely be for four to six years and have a high balance and interest rate.

Two, how reliable are the current cars? A reliable car with little value is much better than a valuable car with high maintenance and repair costs. Paying on a reliable car for three or four more years is better than surrendering the car and buying something with a lower payment but reliability issues.

Third, do you have to reaffirm the car loans while inside bankruptcy? This is very important. If you reaffirm the car while inside bankruptcy, you must pay it off. A reaffirmation agreement is a legally enforceable contract, filed with the bankruptcy court. It states your promise to repay all or a portion of a debt that may otherwise have been subject to discharge in your bankruptcy case.

Some lenders demand you sign this agreement and will not send you statements or report payments to the credit bureau without the court-approved reaffirmation agreement. In many instances, lenders consider it a breach of the terms of your loan if you fail to sign the agreement, and will repossess the vehicle.

However, some lenders do not require you to reaffirm the car loan. That means you can continue making payments and keep the car. If you decide you do not want to keep the car at any point, you can surrender the vehicle even after the bankruptcy is over and not be liable on the remaining balance. I never advise clients to reaffirm a car unless it is mandatory. And when it is mandatory, I discuss whether they ought to keep the vehicle.

Finally, what is the current value of the vehicles? You might be able to lower the outstanding balance to the fair market value. This is done through the bankruptcy court and is known as "redeeming" the vehicle at the fair market value.

Here's how it works. If the value of the vehicle has depreciated considerably since you bought it, you might be able to redeem the vehicle with a new car loan that pays off the old one, reflecting current value. The new loan will be completed before your case is closed. The section of the bankruptcy code that covers this scenario is known as 722 Redemption, and there are finance companies that specialize in it.

As you see, you have a few things to consider before deciding whether to surrender the vehicles. You need to analyze your options in terms of what is the best decision for you and life after bankruptcy.

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