Bankruptcy and Family Car Loans

I was asked today to address a very common mistake people make before filing bankruptcy. The prospective debtor borrowed money from his parents to buy a car. The car was titled in the debtor’s name. The debtor signed a promissory note for the amount of the loan made payable to his parents, but the parents did not record a lien on the car title. Now the debtor is considering bankruptcy, and he wants to know how the legal status of his debt to his parents for the car. He also asks whether his parents should put a lien on the car title before he files bankruptcy.

This is not a good situation for either the debtor or his parents in bankruptcy. The car loan from his parents is unsecured. The debtor may pay his parents back if he wants to, but technically, the parents cannot ask for repayment after the bankruptcy is filed. The car is unencumbered, and if there is equity in the car, the trustee will demand payment for the equity over the $1,000 Florida car exemption. Also, as the car loan is not a secured debt, monthly payments to his parents will not count a secured debt in the debtor’s means test calculations which will make it more difficult for the debtor to qualify for Chapter 7 bankruptcy. If the debtor sells the car and purchases a new car subject to a car lien he still may be liable to the trustee for the excess equity he received from the loan and reinvests in a new car.

The lesson is that if you borrow money from a family member to buy a car, house, or any other item, make sure you document the loan the same way a bank would. If it’s a house, have the family member record a mortgage; in the case of a car, put the family member as a lienholder on the title. This protects both you and your family member if you later have creditor problems.

posted by Jonathan Alper, bankruptcy and asset protection lawyer, Orlando, Florida