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How Does Chapter 7 Bankruptcy Work?
Many prospective clients contact us with the question, “If I declare bankruptcy, what happens to my car?” It’s an important issue to discuss; but before our Sacramento bankruptcy attorneys explain how motor vehicles are treated in Chapter 7, let’s reverse gears, so to speak, and begin with a quick overview of how Chapter 7 bankruptcy works.
As personal bankruptcies go, Chapter 7 is a fast process that generally takes about four to six months to complete. (By comparison, Chapter 13 bankruptcy requires a time commitment of three to five years.) There is normally a filing fee for Chapter 7, but the fee can be waived under certain circumstances.
A person who files bankruptcy is alternately referred to as a “filer,” “debtor,” or “petitioner.” For simplicity’s sake, our Sacramento Chapter 7 lawyers will use the term “debtor” throughout this article.
When a debtor files Chapter 7, the bankruptcy court assigns a person called a “trustee” to manage the “bankruptcy estate,” meaning the debtor’s property. The trustee is permitted to sell many of the debtor’s possessions, though in most cases, this does not occur. The proceeds from the sale help to repay the debtor’s creditors, and the debtor is relieved of most debt, including medical debt, credit card debt, and personal debt. The benefit of this arrangement – besides getting a clean financial slate – is that the debtor does not have to create a repayment plan or make monthly payments to creditors, as he or she would have to in Chapter 13.
Even though the trustee can sell (“liquidate”) various items that belong to the debtor, including the debtor’s car, it is rare for this to actually happen. On the contrary, Chapter 7 debtors are usually able to keep their vehicles. Continue reading to find out why.
If I Declare Bankruptcy, What Happens to My Car?
There’s a stubborn myth that you will lose all of your property if you file Chapter 7 bankruptcy. Fortunately, that is untrue for most debtors. In fact, the majority of Chapter 7 debtors are able to protect most if not all of their personal property – including motor vehicles. But how?
When you file Chapter 7, you are entitled to a set of “bankruptcy exemptions,” which allow you to protect certain assets from sale or liquidation by the trustee. That way, you will not be starting from scratch without any property once your case has been discharged by the bankruptcy court. After all, the purpose of bankruptcy is to help debtors get back on their feet – not punish them for past financial hardships.
Some states allow debtors to choose between federal exemptions and state exemptions, while others – including California – require debtors to use state exemptions. You may choose between “System 1” and “System 2” of exemptions. Depending on which set you select, and the value of your vehicle, exemptions could be sufficient to prevent your car from being repossessed and sold.
The System 1 motor vehicle exemption is $3,050 in California. In other words, you can exempt up to $3,050 of “equity” in your car, truck, SUV, or whatever type of vehicle you happen to drive. Equity is the value of the vehicle. For example, if your vehicle is worth $20,000, but you have auto loans that add up to $17,000, you have $3,000 in equity. Since that figure is lower than the System 1 motor vehicle exemption ($3,050), your car would be fully exempt, meaning it would not be sold by the trustee.
If you had more equity in the car – for example, $5,000 instead of $3,000 – System 2 could be more appropriate. The System 2 motor vehicle exemption is more generous at $5,350, which is $2,300 higher than the California motor vehicle exemption under System 1.
Of course, your vehicle isn’t the only factor you need to think about when choosing exemptions. For example, even though System 2 allows debtors to exempt greater amounts of equity in vehicles, System 2 also has a smaller homestead exemption than System 1. The property you own, the loans you have obtained, the worth of your assets, and your goals for the bankruptcy must all be weighed carefully by a Sacramento or Roseville Chapter 7 attorney when you are filing for bankruptcy in California.
If you cannot exempt all or most of your equity in your vehicle, the trustee will need to assess the vehicle’s value to determine whether a sale would be appropriate. Even if the trustee does decide to sell your vehicle, you are entitled to the full exemption amount from proceeds of the sale.
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