Should I Purchase a New Car Before Bankruptcy?
April 25, 2011
By: David M. Serafin
Many bankruptcy debtors own an older, paid off vehicle with little value. You almost certainly have incurred a significant level of secured and/or unsecured debt if contemplating bankruptcy in Colorado. It would seem counter-intuitive to advise a bankruptcy client to incur even more debt prior to filing chapter 7 or chapter 13 bankruptcy. But, the Means Test and the new bankruptcy laws often reward the bankruptcy filer who purchases a new car right before filing bankruptcy.
Obtaining a car loan after a bankruptcy has been filed can be difficult because the bankruptcy will immediately show on your credit report. Even if you do obtain post-bankruptcy vehicle financing, the interest rate will be higher and the lender may first demand that you remain personally liable for the debt – by signing a Reaffirmation Agreement.
Thus, it often makes sense to buy the car before you file for bankruptcy – especially if you have a good credit score. (In chapter 13 cases, which typically last from 3-5 years, you can purchase a vehicle after filing for bankruptcy but permission from the bankruptcy trustee and Colorado Bankruptcy Court is first required.)
Financing a new vehicle before bankruptcy will also mean a lower interest rate. Regularly making the monthly payments will show favorably on your credit report. (But, if you have a less than stellar credit score, you may want to keep the other vehicle, save money over time after filing the bankruptcy, and then use these funds to either repair the current vehicle or purchase for new vehicle for cash.)
Also, in both chapter 7 and 13 bankruptcy cases, the Means Test created under the new bankruptcy laws in Colorado allows a bankruptcy debtor to take a deduction against gross income for both vehicle ownership and operating expenses (which doubles for married couples, with two vehicles, jointly filing for bankruptcy). Such a Means Test deduction for a vehicle related secured debt may allow a bankruptcy debtor with higher than average gross income to pass the Means Test and qualify for chapter 7 bankruptcy. Similarly, for chapter 13 bankruptcy debtors, a deduction for the purchase of a new vehicle will allow more disposable income to be made for the car payment, with less disposable income paid to the bankruptcy trustee on behalf of unsecured creditors.
Regardless, be aware that the vehicle exemptions in Colorado are $5,000 for single bankruptcy filers and $10,000 for joint filers (these exemptions double for each debtor who is elderly or disabled). You risk either a chapter 7 trustee requesting turnover of your car or having to pay back the non-exempt equity in chapter 13 if the aggregate amount of non-exempt equity exceeds the allowances in Colorado.