How Do You Redeem a Car in Chapter 7 Bankruptcy?

Contrary to some assumptions, debtors in chapter 7 bankruptcy do not have to turn in their vehicles, as a general rule. The most common problem debtors face in fact is not whether their trustee or lender is going to take back their cars against their wishes, but rather whether it is in their best interest to keep their car.

The problem scenario typically unfolds like this: A debtor files bankruptcy while possessing a vehicle that is worth considerably less than what the debtor owes. The debtor therefore is left with a dilemma. Does it reaffirm the underwater car note or should he/she give up the vehicle he/she needs in exchange for discharging the note. In other words, does the debtor decide to keep a $20,000 note on a $10,000 car so it wont have to find a new car or does the debtor get rid of a $20,000 note on a $10,000 car, but leave oneself without a car?

This problem decision is further complicated by the fact the debtor almost certainly knows it will be hard to qualify for a loan for a new car and does not have enough cash to outright purchase a new vehicle. When faced with this scenario, debtors should consider the option of redeeming their car.

11 USC 722 states An individual debtor may, whether or not the debtor has waived the right to redeem under this section, redeem tangible personal property intended primarily for personal, family, or household use, from a lien securing a dischargeable consumer debt, if such property is exempted under section 522 of this title or has been abandoned under section 554 of this title, by paying the holder of such lien the amount of the allowed secured claim of such holder that is secured by such lien in full at the time of redemption.

In plain English that means chapter 7 debtors have the option of paying the fair market value (i.e. allowed secured claim”) for the car rather than continuing on with the same note. Paying the fair market value is known as redeeming, whereas continuing on with the same note is otherwise known as reaffirming.

However, there is a catch. The debtor is not allowed to just take the existing interest rate with the current lender and then reduce the overall balance to the fair market value. What the debtor must do is immediately pay the lender the fair market value. Since the debtor presumably does not have the funds for this payoff, the debtor must seek a loan.

While the funds can come from anywhere, perhaps from the debtor himself or a family member, the majority of the time this transaction is funded by a redemption company lender. This requires qualifying for a loan, often at an interest rate in the 20-25 percent range. Debtors with steady income and no prior history of vehicle repossession can often qualify.

So while the debtor might see its interest rate jump, the principal balance reduction can be so substantial that the debtor often experiences a sharp decline in his/her monthly payment while keeping the car. In fact, if the debtor qualifies to redeem the existing vehicle, he/she could also give up that car and purchase a new car, with the same lender providing the funding.

It is important to note that while redemption is typically used for cars, debtors can redeem other personal property besides vehicles. This provision is often used to redeem furniture as well. It also should be noted that while vehicle redemption under 11 USC 722 is not used in a chapter 13, a somewhat similar provision called a cram down can be used by chapter 13 debtors to reduce their car note balance.