Sometimes the bank forgets to file the paperwork to put a lien on a car’s certificate of title when they make a car loan. Does that mean you don’t owe the money? Or if you file bankruptcy, you get the car for free?
Usually it’s not so simple. When you take out a loan on a car or to buy a car, you actually have a couple parts to the agreement. You have a loan that you owe. It happens to also include a security agreement which is your pledge of the car (and sometimes other property) as collateral for the loan. The lien showing on the car title is the way the bank notifies the world that they have a “secured interest” in that car. In other words, the lien on the title is the bank’s way of telling other creditors or buyers of a car that they(the bank) has first dibs on that car (or the proceeds from the car) before you.
If the bank fails to property record the lien — which is called “perfecting a lien” — then future buyers or creditors may not have to honor the bank’s rights in the car (or right to the proceeds) since they may not know about that right. But this doesn’t change your obligation to pay the debt. And your security agreement pledging the car as collateral for the loan is still binding between you and the bank — so you can’t sell the car and pocket the money without paying the bank first. Doing so on purpose could be fraud on the bank, so that’s usually a bad idea!
In bankruptcy, this gets more complicated. In a Chapter 7, the bankruptcy trustee is treated as though he is a buyer of the car without any notice of the lien, if it is not properly “perfected” under your state’s laws. If the car is worth substantially more than your allowed exemption in a car, he might liquidate the car and distribute the proceeds to all creditors, and the bank would have no lien on those proceeds. And of course you will have lost a car. (The situation is even more complex if there is a lien but the trustee can strip it off the car using his “avoiding powers.”)
In Chapter 13, the unperfected lien might mean that you get to keep the car — but have to pay its market value to all creditors through the plan in return for keeping it. Because the bank would have normally been paid at least that much plus interest in your Chapter 13, that is usually a good deal for the consumer. So one way or the other, you’d probably end up paying for the car to keep it — but if the bank screws up and you need the car, Chapter 13 may be the place to be.
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Last modified: May 21, 2013