What if my car is upside down? And I don’t mean lying on its roof with the wheels pointing upwards and spinning. Being “upside down” refers to a loan secured by a car where the balance due is higher than what the car is worth. For instance, a 2003 Chevy Blazer may be worth $8,000, but the balance on the loan may be $14,000!

How does this happen? There are several ways… It may be that a trade-in was rolled into a new car loan, causing the new loan to be much higher from the beginning. It may be that the term of the loan was longer than the usual 36-48 months, causing a balance to exist as the car nears the end of its useful life. Or it may be that the interest rate on the loan was unusually high, slowing down the pay down of the principal balance.

In any event, what do you do with a car that’s upside down? In a Chapter 7 bankruptcy, one has three options. The first option is to keep making timely payments on the car as always. This would enable the owner to keep their car with no changes to the payment or total amount due. This option may be sensible if one is not behind on the payments and where the negative equity (the “upside down” factor) is not significant.

Another option is to “surrender” the car — simply give it bank to the finance company and walk away. The key difference between doing so while in a Chapter 7 bankruptcy as opposed to a voluntary surrender or repossession is that when done through the bankruptcy the consumer will not be responsible for the difference between the car’s value and the balance of loan. This is called a “deficiency.” In our example above, if the person decided to surrender the 2003 Chevy Blazer without a bankruptcy, the finance company could potentially sue the person for $6,000 — that is the difference between the value of the car, $8,000, and the balance due on the loan, $14,000. However, when a car is surrendered through a bankruptcy, the person will NOT be responsible for any deficiency, which in most cases is discharged along with the other debts.

The third and the most interesting of the options is called “redemption.” This is a right granted by Section 722 of the United States Bankruptcy Code. In short, the section applies to tangible personal property (meaning, it cannot be a house) that is intended primarily for family or household use and that has been exempted or abandoned by the Trustee. In most cases, a family car will be exempted and the Trustee won’t be interested in it.

To redeem something means to pay the finance company the current value of the property in exchange for full ownership. Going back to our 2003 Chevy Blazer example, the finance company MUST release all liens and turn over a clean title to the car upon receiving a payment of $8,000, which is the current value of the car. It does not matter that the balance on the loan is $14,000. The company will have to eat the $6,000 difference and take it as a loss.

One might ask, where does someone going through a bankruptcy get $8,000? Sometimes this money comes from family or friends. For others, certain companies offer special redemption loans to persons going through bankruptcy for this very purpose. In our example, one would get a new loan for $8,000 from one of these companies, essentially refinancing the car for almost half the amount of the prior loan. Naturally, the interest rate on a redemption loan would be higher than regular car loans, but in most cases the monthly payment will be substantially lower than before. In addition, one can do a redemption even if they were many months behind on their car payments, as long as the car has not yet been sold at auction, without being held responsible for the missed payments.

Practically speaking to perform a redemption one has to file a motion with the bankruptcy court and propose a value of the redemption. The financing company can then propose their own value, in which case the judge will decide what the redemption value should be. Even though everyone uses Kelley Blue Book and NADA guides as the standard for determining value, disagreements occur because of issues like mileage, mechanical condition, cosmetic damage, etc. In the end, the redemption price is either agreed upon or court ordered. The process usually takes less than a month from start to finish, and is done seamlessly within the ongoing bankruptcy case.

It must be noted that some attorneys charge extra to do redemptions in addition to their regular Chapter 7 fees. One must consult their attorney fee agreement to see if additional costs will be involved.

In the end, a redemption is an excellent and powerful choice for consumers whose car loans are upside down and who wish to keep their cars. It forces the finance company to accept less than the balance of the loan, a figure based on the car’s current value, which may end up saving the consumer thousands of dollars.