Thursday, October 13, 2011

How redemption helps fix an upside down auto loan in Chapter 7

Debtors have a few options when in comes to keeping a vehicle loan through chapter 7. The most common options are to simply keep paying on the loan and the lender accepts the payments and lets the debtor keep the car. Once the loan is paid off, the lender will have to turn over the title. This is known as the "retain and pay" option. Some lenders will not allow this and will require the second option known as "reaffirmation". A reaffirmation requires a debtor to assume personal liability on the loan after the bankruptcy by signing a new agreement. This means that if the loan defaults in the future and the car is repossessed the lender has the right to pursue the debtor for the deficiency balance, despite the bankruptcy discharge.

A lesser used option is called "redemption".  Under bankruptcy law a debtor may pay the lender the value of the collateral and the lender must release the title. This can help when a car is underwater (debtor owes more than the value of the car).  For example, if the debtor has a vehicle worth $10,000 and owes their bank $15,000, they are underwater on the loan by $5,000.  In this example if a debtor would be able to pay the bank $10,000 in a lump sum they could "redeem" the car and get the title. This essentially strips off the negative equity and also saves the debtor lots of money in future interest that would be paid on the loan.

Obviously it is difficult for many debtors to come up with that sort of money to redeem a car.  I have had clients lucky enough to borrow money from friends or family to redeem vehicles.  Another option is to get a redemption loan. This would be a new loan given to the debtor to pay off the value of their car on the current loan. The debtor would then pay the new loan. This really only makes sense if the new loan pencils out to save the debtor money in the future. It can help when there is significant negative equity in the car because the new loan will be based on the value of the car, not the balance on the existing loan.  One prominent company offering redemption loans is 722 Redemption Funding, a branch of US Bank. They can be found at

When weighing options for keeping a vehicle in chapter 7 it usually helps to discuss all facets of the decision with your attorney. A good bankruptcy attorney will be able to let you know what options makes the most sense.

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