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How does lien-stripping affect car ownership during bankruptcy?

Vehicle lien-stripping has limits under bankruptcy rules

When property owned by someone filing bankruptcy has less value than the original loan used to finance it, debtors have the ability to strip a lien that was attached to the item. It's a fairly common occurrence used on vehicles, but one that has some limits.

Since liens are secured debts linked to tangible assets, they can only amount to the value of the property. Once the loan exceeds that amount, the difference between current market value and the lien becomes an unsecured debt that can be discharged by the U.S. Bankruptcy Court.

Under the 2005 reforms to the United State Bankruptcy Code, court officials reduced the instances of lien stripping for newer vehicles by instituting a 910-day limit. That meant cars bought within the approximately two and one-half years prior to a bankruptcy filing were subject to a new ruling. Lenders were allowed to retain the full amount of the debt, instead of reducing it to its current value.

In Chapter 7 bankruptcy cases, the situation is straightforward - debtors must sell their non-exempt possessions to pay off creditors. Usually, state and federal exemptions will cover the value of a vehicle and its owner will not have to relinquish it. When the value is higher than the exemption allows, the car has to be sold unless debtors can show the court that they are able to make monthly payments once other debts are resolved.

Chapter 13 rules

For those who file under Chapter 13, the process is more complicated. While the automatic stay enforced during bankruptcy proceedings will prevent immediate repossession, a creditor has the right to ask the court to set aside the stay if the debtor is behind on car payments.

At the same time, creditors are barred from taking possession of a vehicle if Chapter 13 filers are making the monthly payments required in their court-ordered repayment plan.

For cars bought before the 910-day look-back period, the payments are based on the vehicle's value at the time the bankruptcy was filed. But when this rule comes into play, the payments must cover the full amount of the debt against the car plus interest, according to the National Association of Chapter 13 Trustees (NACTT).

"In most jurisdictions, if the equal monthly payments do not begin in month one of your plan, you must pay the creditor special payments called 'adequate protection' until regular payments begin," states the NACTT.

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