Don’t Fall Into the Painful and Expensive Chapter 13 “Car Trap”...

Filing a chapter 13 bankruptcy case is sometimes necessary because of having debts which can’t be discharged in chapter 7, having non-exempt property, or having too much income to file chapter 7.  When you make the decision to file a chapter 13 case, be sure you consider your options regarding the financing on your motor vehicle.  If you don’t give this careful thought, you might end up falling into the chapter 13 “car trap.”

A chapter 13 lasts for either three or five years, depending on whether your income is above or below your state’s median income for a household of your size.  While it is certainly possible to obtain financing for a vehicle loan during the three to five years you are in chapter 13, it is much easier to do before the chapter 13 is filed.  Also, you are sure to get better credit terms for a vehicle loan obtained before the case is commenced.

The chapter 13 “car trap” springs into existence when you file chapter 13 having an older car that might not survive for the duration of the case — or, even worse, having such an older car which is subject to a hefty car loan on the date you file chapter 13.  The car trap springs its jaws on you when, midway through the chapter 13, your older car dies or becomes expensive to maintain, forcing you to consider taking out a car loan to once again have reliable transportation.

It is easy to see how this is a financially painful trap: you are already paying what you can afford each month into your chapter 13 payment plan.  Where will you get the additional funds to pay for a new monthly car payment?  For many, finding the money for new car payment in the middle of a chapter 13 case could be difficult or even impossible.

Thankfully, the chapter 13 car trap can be avoided by careful planning undertaken before the case is filed.

Step One: consider whether your vehicle is in good enough condition to last for the entire duration of your chapter 13 case.  If your vehicle can last that long with no problems, then the chapter 13 car trap is unlikely to spring on you, and you can forget about this entire issue.  However, if your vehicle is not likely to give you safe, reliable transportation for the whole time you are in chapter 13, the car trap can be avoided by proceeding as explained below.

Step Two: get yourself a car that will last all the way through your chapter 13 case.  This most likely will mean that you will need to take out a loan to purchase a new, or newer, vehicle.  The payments should last for the entire duration of the case.  This way, you can either pay for the car loan yourself (outside the chapter 13 plan), or your chapter 13 plan monthly payment will cover the cost of paying for the car in full.  Either way, you get to keep the newly purchased vehicle, and your unsecured creditors will simply receive a smaller level of repayment in your case.  Additionally, you are obtaining the new vehicle with no impact on your monthly cash flow.  This is because either your chapter 13 payment is being reduced doller-for-dollar by the new car payment, or your chapter 13 plan payment includes the car loan payment and your other creditors simply get less money.

Avoiding the chapter 13 car trap in this manner requires in-depth guidance from your bankruptcy lawyer to avoid any claim by the trustee that you incurred the new car loan in bad faith.  However, this should not be a problem because the U.S. Supreme Court, in Milavetz v. United States, 2010 U.S. Lexis 2206 (2007), specifically approved the idea of incurring a debt just prior to a bankruptcy filing, so long as you intend to pay the debt in full and don’t incur the debt with a bankruptcy motive.  It is important that the new vehicle be necessary, within reason, for the maintence of your household or getting to and from work.  The new vehicle purchase must also be motivated by your need for reliable transportation, and not by your impending chapter 13 filing.

If your not-so-reliable vehicle is subject to an existing car loan, your chapter 13 plan will most likely provide that you will surrender that car as part of the chapter 13 filing, and that the lender will have an unsecured claim, fully dischargeable in the chapter 13 case.  Also, it is almost certainly better to avoid trading in your older vehicle to obtain the newer vehicle.

Photo courtesy of Anthony DeLorenzo, http://www.flickr.com/photos/delorenzo/2688406674/.