In Chapter 7, there are three possibilities for dealing with a debt that is secured by collateral, one of which is a “redemption”. Redemptions are usually only done with regard to vehicles, though it would be theoretically possible to do it with other types of personal property too. This article deals with redeeming cars. This is possible in Chapter 7, but not Chapter 13.
First, with the agreement of the creditor, you may keep the car, and continue your obligation to pay for it. This is called a “reaffirmation”. The effect is to leave the car out of the bankruptcy and continue to pay for it, usually under the terms of the original contract. A reaffirmation usually requires that you be current in your payments on your car note.
The second possibility is to “surrender” the collateral. In that case, you lose the car to the creditor, and the debt is discharged. The creditor can’t collect any money later. This makes sense when you can’t afford the debt, or if something is wrong with the collateral so that you prefer to pursue other options. You can certainly surrender the collateral even if you are behind on the debt and a “reaffirmation” is not possible.
The third possibility is a “redemption”. Redemption is a remedy that exists only under the bankruptcy code, and so you have to file a Chapter 7 to take advantage of it. It is perfectly legal, and is easily achieved in the right circumstances. You don’t need to be current in your payments to redeem. This remedy will surprise you, and is not obvious at all.
The Code provides that if a debtor pays the “fair market value” of personal property in a lump sum, that the creditor must accept the money in exchange for its lien rights. The challenge is that debtors do not have enough money to make large lump sum payments. The solution is that a few banks make money by financing a bankruptcy redemption if the circumstances qualify under their guidelines. The practical effect of a redemption is that the debt is refinanced: the old debt is satisfied, and a new, lower debt/loan is created in its place with a new lender. That lender becomes the lienholder in the place of the original creditor.
The right “circumstances” are as follows: 1) the car must be relatively new (10 years or less and less than 150,000 miles), and 2) the debt must not be co-signed, 3) the debt should significantly exceed the value of the collateral securing it, and 4) your provable income should be high enough to make the payments.
The debt might exceed the value of the collateral for several reasons. One is where the debtor rolled a pre-existing debt into the price of his car when he bought it (in other words, the trade-in was not paid off). Another circumstance is where the lender (usually a credit union) has “cross- collateralized” the car note with some other debt, such as a loan or credit card. In that case, the car may be collateral for both the car note and for the other “unsecured” debt based on the language in the loan agreement. Third, high finance charges, late-fees, or other charges may have driven up the pay-off to a figure that is much more than the value of the car.
If your car is relatively new and is worth significantly less than what is owed on it, we can explore