Disappearing Debt: A Common Misconception About Bankruptcy

The other day a prospective client came to my office for a free bankruptcy consultation.  Her case wasn’t terribly complicated. Her most pressing concern was that she didn’t want to lose her car. She was afraid that if she included her car in the bankruptcy, the bank would be forced to take it away from her. In responding to this concern, I found myself answering one of most interesting questions, and at the same time common misconceptions, about bankruptcy. And that is…

What Happens To The Debt When A Person Files For Bankruptcy?

Most people think that the debt just goes away. Wrong! When you file for either chapter 7 bankruptcy or chapter 13 bankruptcy, the debt still exists. The only thing that goes away is your liability for the debt.

Confused?

It helps if you think of debt in two separate parts. Those parts are:

  • The Money That Is Owed
  • The Liability Of The Person Who Owes It

Now let’s bring the woman’s car into the context of those two parts of debt.

Part 1: There is money owed on the car loan. That is an absolute. The only way to make it go away is to pay it.

Part 2: She is liable (which is another way of saying “responsible”) for the money that is owed. Her liability (or responsibility) is not an absolute. Bankruptcy relieves her of that responsibility. Once the responsibility is gone, it’s gone. She can’t be made to pay for something the courts have relieved her of personal liability/responsibility for.

So, there is still debt, it just isn’t hers (or yours, as the case may be).

So Does This Mean I Get A Free Car When I File For Bankruptcy?

Nope. Or, at least, the answer is “nope” assuming you bought the car the same way everyone else does – with a “secured loan.” A secured loan is a debt in which money is owed and collateral has been pledged as security for the loan. When a person receives a loan to buy a car, the car typically serves as collateral. Same thing goes for a mortgage – you get a loan to buy a house, the house is the collateral. Sometimes furniture or appliances are used as collateral on the line of credit used to purchase them. These are all secured debts.

A key component of nearly every secured loan is that the loan contract gives the lender the right to repossess the collateral (the car, house, furniture, or appliances) if payments are not made towards the debt. The lender has that right until the debt is extinguished.

So, Are They Going To Take My Car or Aren’t They?

That was the original question, wasn’t it?

Well, because I’m a lawyer, I have to say “There are several scenarios that would need to be considered to answer this question fully.” But the best rule-of-thumb is that if you keep making your payments on your car after you file for bankruptcy, you can keep your car.

So, now let’s add a twist to this scenario. Say you keep your car with the intent to keep making payments, but somewhere down the road your situation changes and you can no longer make the payments. The bank would then have the right to come and take (repossess) the car. (I want to reiterate here: If you want to keep your car after you file for bankruptcy – just keep making the payments on time!)

What Happens If They Take My Car After I File For Bankruptcy?

You defaulted (failed to make the payments) on the car loan. The bank repossessed the car. Now what?. Well, the lender is required to sell the car (typically at auction). The hope is that by selling the car the loan can be satisfied (paid off). If the car sells for more than the value of the loan, the excess proceeds from the sale must be given to you. Most of the time, however, the car is sold for less than the balance of the loan. The unpaid balance of the loan is called the deficiency.

Can The Bank Try To Collect The Deficiency From Me After They Sell My Car?

To answer that question, let’s consider two key points I’ve tried to make in this post:

  • You can only be sued for a debt that you are personally liable to pay.
  • Bankruptcy eliminates personal liability towards debt.

So based on those two points, we can fairly and accurately conclude that you cannot be sued for the deficiency from the sale of your car if you filed for bankruptcy. More plainly stated, the bank cannot sue you for the deficiency because you filed for bankruptcy and are thus no longer personally liable for the debt.

I hope this clears up any misconceptions you might have had about disappearing debt and what becomes of collateral when a person files for bankruptcy. If you have any further questions, or would like to schedule a free bankruptcy consultation, please contact Marks Law Firm today.

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