How To Redeem Your Car in Bankruptcy

The Bankruptcy Code provides several options to help bankruptcy debtors keep and pay for their cars. Redemption is one of these options. Redemption is often most helpful for debtors who are upside down on their loans — in other words, those who owe more than the car is worth. Redeeming your car in bankruptcy allows you to pay your vehicle’s retail value instead of the full balance you owe on your loan. The downside is that you must pay this amount in a lump sum. 

Chapter 7 Bankruptcy and Your Car

Your options for dealing with your car in Chapter 7 bankruptcy depend on how much your car is worth, how much you owe on it, whether your payments are current, and other factors. Generally speaking, these options include:

• Reaffirm: If you’re current on your car payments, you and your lender can agree to carry on as if the bankruptcy never happened. The bankruptcy court must approve the reaffirmation agreement. You’ll keep your car and continue making the regular payments. If you default on your payments in the future, your lender can repossess your car or take other action.

• Surrender: If you’re behind on your payments or want a way out of an unaffordable loan, you can voluntarily turn the car over to the lender. You won’t be responsible for any more payments or charges, even if you owe much more than your car is worth. 

• Redeem: If you do owe more than your car is worth, bankruptcy law allows you to pay only the car’s value, not the whole balance. This is called redeeming your car. Redemption is discussed in detail below.

These options are only available in Chapter 7 bankruptcy. Chapter 13 debtors have a different set of options for dealing with car loans. Also, these options don’t apply to leased or lease-to-own cars. Leases have their own set of rules under the Bankruptcy Code.

What Does It Mean To Redeem Your Car in Bankruptcy?

Redeeming your car in bankruptcy is not the same thing as using your right of redemption. Under state law, redeeming your loan means paying the entire loan balance, not just the past-due portion. This includes any late fees, accrued interest, and repossession costs. Most states have redemption laws, though the requirements vary from state to state.  

When you redeem your car in bankruptcy, you pay the car’s value instead of the loan’s outstanding balance. The idea is that if the bankruptcy trustee liquidated your car, your lender would only be entitled to what they could sell it for at auction — the car's market value. Bankruptcy redemption is sometimes called 722 redemption because it’s created by Section 722 of the Bankruptcy Code.

Benefits of Redeeming Your Car in Bankruptcy

If you owe more on your car loan than the car is worth, redemption can save you a lot of money. Not only will you not have to pay the full loan balance, but you also won’t have to pay interest on that full amount. The difference between the value and loan balance is discharged in your bankruptcy case, meaning you aren’t responsible for paying it. Also, unlike reaffirmation, you don’t have to be current on your loan payments to redeem your car in bankruptcy. 

Drawbacks of Redeeming Your Car in Bankruptcy

The biggest drawback of redeeming your car in bankruptcy is that you must pay the car’s full value, usually in one lump-sum payment. Most people who file Chapter 7 don’t have access to that much cash. One solution that has emerged in recent years is redemption funding — lenders that specialize in bankruptcy redemption. Redemption lenders loan you the money for the lump-sum redemption payment, then you repay the redemption loan over a set term. In essence, you’re refinancing your original auto loan, with a reduced principal amount.

Be careful, though. Redemption lenders tend to charge fairly high interest rates for these loans. Your new interest rate could be higher than your old rate. But redemption could still save you money, depending on how much the principal balance is reduced. 

A good way to tell if you’re saving money is to use a loan calculator. Enter your current loan balance, including all past-due amounts, interest charges, and fees, along with your current interest rate and loan term. Then repeat the calculation using the new balance, interest rate, and loan term, and compare your results.

Avoid any redemption lenders that use predatory practices, such as balloon payments, hidden charges, or high loan origination fees. In addition to these niche lenders, it may be helpful to contact other lenders, such as the bank or credit union where you keep a checking or savings account. 

The lump-sum requirement is the biggest drawback to bankruptcy redemption, but there can also be other challenges. Many bankruptcy lawyers don’t include redemption under their standard Chapter 7 attorney’s fee. If you’re working with a bankruptcy attorney, you may have to pay them an additional fee for handling the redemption paperwork and hearing, plus negotiating with your existing lender if the lender disagrees about your car’s value. On the other hand, if you’re not working with a bankruptcy lawyer, you’ll need to handle those issues yourself.

How To Redeem a Car in Chapter 7 Bankruptcy

1. Determine your car’s market value. NADA, Kelley Blue Book, and Edmunds all offer instant online calculators. Print or save your results as evidence.

2. Determine the total amount you owe on your auto loan. Include the full principal balance plus any past-due amounts, accrued interest, late fees, repossession costs, and finance charges. If this total is substantially higher than your car’s value, redemption may be a good option.

3. If you don’t have access to enough cash to pay your car’s value, contact a few lenders. You can find redemption funding companies online by searching for “redemption funding” or redemption financing.” You can discuss with them whether it is feasible for you to redeem the vehicle. Compare offers from different lenders, if possible. Use a loan calculator to be sure redemption will save you money.

4. You or your attorney must prepare a Motion to Redeem and file it with the bankruptcy court. The Indiana branch of the U.S. Bankruptcy Court provides an example Motion to Redeem you can reference to see what it should look like. Your bankruptcy court may have a different form to use. You may need to attach your car valuation printout from Step 1 as an exhibit.

5. After you file the motion, you’ll need to send copies to your original lender and your bankruptcy trustee. Then file a certificate of service to let the court know.

6. If your original creditor doesn’t agree with your numbers for your car’s value, they may contact your attorney or file a response or objection to your motion. In this case, you may have to negotiate with the creditor about your car’s condition and value. You can usually reach an agreement outside of court.

7. The Motion to Redeem must be approved by the bankruptcy judge. Depending on your local procedures, you may not need to appear in court. If the judge approves, the court will enter an order approving the redemption. You or your new lender will need to pay the agreed value to the original lender within a set time after the order is entered — usually 10–30 days.

8. Once the payment is processed, your original lender will release its lien on your car or transfer the lien to the new lender.

After the lien changes hands, you’re responsible for paying the new lender according to your new loan terms. The redemption loan was made after you filed bankruptcy, so this new loan won’t be included in your bankruptcy discharge. If you don’t make the payments as agreed, your new lender will be able to pick up your car or take other action according to your state’s law.

Let’s Summarize…

Redeeming your car in bankruptcy is an option that allows you to satisfy your car loan by paying your car’s value instead of your full loan balance. This can save you a lot of money in both principal and interest payments. The downside is that you must pay the value in a lump sum. If you don’t have enough cash on hand to pay the lump sum, you may be able to borrow it. Redemption lenders specialize in loaning Chapter 7 debtors the funds to redeem their cars. You can use a loan calculator to make sure you’re saving money by using a redemption loan. 

To redeem your car, you’ll need to file a motion with the court. You may have to negotiate with your original lender as to your car’s value. The redemption must be approved by the bankruptcy court. If you’re working with a bankruptcy lawyer, you may have to pay them an extra fee to cover the extra work needed for the redemption.