In a declining economy, or as a result of changing individual circumstances, a once prized ‘toy’ can turn quickly into a crushing financial burden. Unfortunately, lenders aren’t all that understanding when you try to simply give back a car or boat that you can no longer afford. The property will be repossessed, but that isn’t always the end of the story. Most lenders will require you to personally guarantee your car loan. After repossession, an auction will commence, which will result in a fire sale of the property, and you personally owing the difference between the sales price and what you owed on the note.
Even When Debts are Forgiven, There are Tax Consequences
Even a voluntary turn over will usually go down on your credit as a repossession significantly damaging your credit. In the event the remaining debt after auction was forgiven, the IRS would come knocking for an increase in your taxes when a 1099 is issued. That’s right, any debt that is forgiven will be imputed to you as income that you will have to pay tax on. So what to do? For most people bankruptcy is a scary word, a last last resort. While it is true that bankruptcy is not for everyone, it can help to mitigate the financial burden of an underwater car.
Surrendering a Car in Bankruptcy
Through a chapter 7 bankruptcy, the debtor has the right to surrender any collateral that serves as security for a loan with no continuing obligation for any remaining debt after the auction sale. Surrendering property in bankruptcy is the equivalent of erasing your personal guarantee from the note. You give back the property and you’re done. The lender can take no further action and the IRS won’t come knocking. People who can no longer afford their car or boat payments can return the car to the lender and walk away (the same is true of leases). Bankruptcy will be a knock on your credit score, but so will a repossession, the difference is that in the repo scenario your credit is damaged AND you are still liable to make payments on property you no longer own.
Chapter 7 bankruptcy provides a unique opportunity to redeem your underwater car by paying its actual value, as opposed to the inflated loan balance. For example, let’s say your car is worth $1,000, but you owe $7,000. In this case, you could pay your lender $1,000 to own your car outright, rather than reaffirming a loan that is way out of line with the value of your car. If you don’t have cash to buyout the loan, there are lenders who can help.
Chapter 13 Bankruptcy
A chapter 13 bankruptcy may be another way of dealing with car or boat payments that are no longer affordable. In a chapter 13 plan, the debtor has the ability to ‘cram down’ secured debts that exceed the value of the collateral. For example, a debtor who owes $10,000 on a car that is worth only $6,000 could readjust the debt to come more in line with the present value of the car. Rather than paying a monthly payment based on the $10,000 debt, the debtor would now pay a monthly payment based on the car’s actual value of $6,000.
Bankruptcy should be a last resort reserved for those in financial distress, having said that, it is a powerful right that consumers should not be afraid to exercise when they need to. Filing for bankruptcy may be the solution to car and boat payments that are too high, consult a knowledgable bankruptcy attorney to discuss your options.