When you borrow money to buy a house or car, that property generally serves as collateral for the debt you owe. That is, you don’t truly own the property until you pay off the debt, and if you stop paying on the loan then more than likely a process will begin that ends with you giving your property back. If you file for Chapter 7 bankruptcy and owe money on property that serves as collateral, then you will need to choose one of three ways to handle that debt.
Surrender of Secured Collateral
One way to resolve the debt you owe on the property is to simply give back the property that serves as collateral — called Surrender. Ideally, you will then not be held liable for the rest of the money you owe on the property. Sometimes, the property will be worth more than your remaining debt – that is, you have some equity in the property. If the property and your equity are exempt from the bankruptcy estate, you’re in luck — you’re entitled to receive your equity in cash. On the other hand, and this is more likely, if the property is an asset of the estate, then the trustee of the estate will probably attempt to sell the property to obtain the equity.
Reaffirmation is an agreement that is typically used with car loans. With this option, you agree to be liable for your pre-bankruptcy debt after you complete your obligations under Chapter 7 bankruptcy. In return, you are allowed to keep the property that is serving as collateral (your vehicle). Typically, the agreement calls for you to make payments while you’re in Chapter 7 and then keep the vehicle after you finish with bankruptcy. The key is that your debt will not be discharged after you complete bankruptcy and you will personally liable for the debt. That’s why you should consider this option carefully, and only exercise it for good reason — for example, if you arrange a better deal on the debt in exchange for reaffirming it.
For people considering Chapter 7, there is a third option to discharge your debt on a specific piece of property, but it is rarely used. This last option is called Redemption, and it involves you buying the collateral out of bankruptcy by paying your creditor the current market value of the collateral. This is rare because it requires you to have a lump sum of cash that is also exempt from bankruptcy proceedings. (On the plus side, this is a viable option in Chapter 13 bankruptcy, which is why we like to meet with anyone considering bankruptcy — we can evaluate your specific situation in order to choose the bankruptcy option most suitable to your particular circumstances.)