Many of my clients say they don’t want to “file bankruptcy on” car loans or home mortgages, which means that they want to keep the car or the house, and keep making payments on the car loan or mortgage. You can do that; but it’s a good idea to understand how car loans and mortgages are treated in bankruptcy.

First, you don’t “file bankruptcy on” one creditor or another. In a Chapter 7 bankruptcy, you are required to list everyone you ow money to–every credit card, medical bill, student loan, personal loan–and also every car loan or mortgage. Every creditor will receive notice of your bankruptcy. You can choose to keep paying a car loan or a mortgage. On your behalf, our firm will file a budget that includes all your monthly expenses, including any car payment and mortgage payment.

What happens to the debt owed to the car lender or mortgage holder during a Chapter 7 bankruptcy is interesting. It may be difficult to imagine that the “debt” and the “lien” are separate, but they are. The “debt” is the amount that you borrowed, and the lender has the right to collect it. The “lien” is the interest in the property, which allows the lender to take possession of the property if you don’t pay back the debt. If you don’t make the payments, the lender can repossess the car or foreclose on the real estate. If there is money still money owed to the bank after repossession or foreclosure–because the car or house is worth less than you owe–that’s called a “deficiency.” The lender can sue you for the amount of the deficiency.

A bankruptcy discharge wipes out the debt, but doesn’t wipe out the lien. If you file Chapter 7, the lender keeps its lien in the property (otherwise everyone who filed Chapter 7 would get a free car and a free house!) but the “debt” is discharged and can’t be collected. This means that, if you don’t continue to pay the debt, the creditor can repossess the car or foreclose on the house. However, they can never collect any more money from you, even if the car or house is worth much less than you owed.

A creditor with a car loan or a home mortgage often sends a “reaffirmation” agreement to our firm, to have you sign. In signing a reaffirmation, you “reaffirm” or “promise again” to pay the loan–which means that this one particular loan is not discharged in bankruptcy. Car lenders usually insist on a reaffirmation, and we advise you to sign it. They have the right to repossess the car if you don’t sign, because they are often not completely protected by insurance if the car is stolen, damaged, or destroyed. A reaffirmation on a home is different, and I am always very careful to make sure you fully consider the consequences of reaffirming a mortgage that may be in the hundreds of thousands of dollars, stretching out over 10 or 15 or 25 years. I generally advise against reaffirming a mortgage.