How Does Bankruptcy Affect a Car Lease?

When it comes to cars and bankruptcy, it’s easy to find information about what happens to a car you own or you’re financing. But what if you lease your car? The day-to-day experience of driving a leased car and a financed car may be identical, but the two are quite different from a legal standpoint. This article covers the key differences between leasing and financing a car and explains how auto leases are handled in Chapter 7 and Chapter 13 bankruptcy.

What's the Difference Between a Car Loan and a Car Lease?

In many ways, car leases and loans are similar. In both situations, you’re in possession of the car, and you’re free to drive it if you keep making the required payments. If you stop making the payments, the car could be repossessed. 

But loans and leases aren’t the same. A car lease is a contract, while a car loan is a debt. Also, after making the agreed payments on a car loan, you get to keep the car. But at the end of a lease term, you must return the car. Finally, the most important difference between a lease and a loan is who legally owns the car. These differences are explained in more detail below.

How Car Loans Work

When you take out a loan to buy a car, your lender essentially buys the car for you, and you pay them back over time. You’re legally the owner of the car, even though it’s not paid for yet. But the contract you sign with the lender contains a security agreement, which gives the lender certain rights to your car:

• The lender can place a lien on your car title. They get to keep the title until the loan is paid off. Then, they release the lien, and the state sends you the title.

• The lender can legally take the car back from you if you don’t make your payments. This is called repossession.

• If you have a car accident, the lender may have certain rights related to the insurance and repairs.

The unpaid balance of your car loan is a debt that you owe. Because of the security agreement, a car loan is a secured debt. Your car is the collateral that secures the loan.

How Car Leases Work

When you lease a car, you aren’t the owner. It’s like renting an apartment: You sign a contract to pay the owner a certain amount each month for a set amount of time. In exchange, you get to live in the apartment. At the end of the contract, you move out and the owner still owns the building. If you don’t pay your rent, the deal is off, and you lose your right to stay in the apartment. 

From a legal standpoint, leasing a car isn’t much different than renting an apartment. You’re not the owner of the leased car. You can keep and use the car during the lease term, as long as you’re making the payments and following the terms of the contract. At the end of the lease, you return the car to the dealership or leasing company. 

Some auto leases contain an option to buy the car at the end of the lease, usually at a discounted price. This can be confusing. A purchase option or a lease-to-own contract may lead you to believe that you’re financing the car instead of leasing it. But an option to buy at the end of the lease doesn’t change the lease into a loan. If you choose to buy the car at the end of the lease, you’ll sign a separate loan agreement at that time. Until then, you’re still leasing.

Leasing Lingo

The language used in auto leasing can also be confusing. Here are some key terms:

• Lessee: That’s you! The lessee is the person who agrees to make payments in exchange for driving the car.

• Lessor: The person or business, such as a dealership or leasing company, that owns the car. The lessor lets you use their car in exchange for monthly payments.

• Lease: The contract or agreement between the lessee and the lessor. The lease contains important information such as the length of the lease, the payment amount, and any other rules, restrictions, or options. The lease is sometimes called the lease agreement or lease contract.

• Lease payment: The amount you’re required to pay the lessor each month during the lease.

Finally, unlike an auto loan, a vehicle lease isn’t a debt. The lessor isn’t a secured creditor, and the lease and lease payments don’t appear on your credit report. One exception is if you have unpaid charges at the end of your lease, such as excess mileage fees. Those charges are considered debts.

What Happens to Your Car Lease if You File Bankruptcy?

How bankruptcy affects your car lease depends on the type of bankruptcy you file, the status of your lease, and whether you want to continue with the lease. In any case, if you file bankruptcy, you or your bankruptcy lawyer must disclose that you’re leasing a car in the bankruptcy forms you file with the court. 

Since you don’t own the car and the lease isn’t a debt, don’t include the lease information on the forms dealing with property or debts. Instead, a car lease belongs on Schedule G of your bankruptcy forms. You’ll need to provide the lessor’s name and mailing address. To describe what the lease is for, you can say “car lease” and include the car’s make, model, and year. It’s also helpful to note when the lease expires.

Car Leases and Chapter 7 Bankruptcy

If you’re filing Chapter 7 bankruptcy, you have to complete a Statement of Intention. As the name suggests, you use this form to tell the lessor your intention for the lease — in other words, what you want to do about the lease. The form only offers two choices:

• If you want to continue the lease, mark “yes” on the form under “Will the lease be assumed?” In bankruptcy lingo, assuming the lease means continuing it.

• If you don’t want the car and don’t want to continue the lease, mark “no.”

You aren’t required to give your lessor any additional notice of the bankruptcy besides the Statement of Intention. That said, under the Bankruptcy Code, you must file your Statement of Intention within 30 days after you first file your bankruptcy case. The 30-day time limit applies even if you have an extension to file other bankruptcy forms in your case. 

If you don’t file your Statement of Intention within 30 days, the bankruptcy’s automatic stay protection for your car will be “lifted.” If the automatic stay is lifted, it no longer applies, which means the lessor can repossess the vehicle. To be safe, most people file their Statement of Intention at the same time as their other bankruptcy forms.

If you want to continue with the lease and keep the car...

If you’re current on your lease payments when you file bankruptcy, you can choose to continue, or “assume,” the lease. If your Statement of Intention says you’re assuming your lease, then your lease will continue as if you hadn’t filed bankruptcy. 

In other words, you must still make your lease payments each month until the lease expires. All the original lease terms and conditions still apply. At the end of the lease, the lessor can still charge you mileage or damage fees according to the lease terms. Just like before you filed bankruptcy, if you don’t make your payments, the lessor can repossess the car and sue you for any amount you still owe on the lease.

The lessor may send a reaffirmation agreement for you (or your bankruptcy attorney, if you have one) to sign confirming that you want to assume the lease. This usually happens because the lessor is confused about what’s required to assume a lease in bankruptcy. Reaffirmation agreements are for secured debts, not leases. You don’t need to sign a reaffirmation agreement to assume a car lease. 

If the lessor insists, though, it may be easier to go ahead and sign the reaffirmation agreement rather than jeopardize your lease. All reaffirmation agreements must be approved by the bankruptcy judge before they take effect. At the hearing on your reaffirmation agreement, you can explain to the judge that this is a lease, and they’ll explain to the lessor that reaffirmation agreements don’t apply to leases.

If you’re behind on your lease payments when you file Chapter 7…

What if you want to keep your leased car, but you’re behind on your lease payments? If you can catch up on your lease payments quickly after you file bankruptcy, you can usually still assume the lease. Your payments must usually be current by the time the lessor receives your Statement of Intention to be able to assume the lease. 

That said, your lease probably gives the lessor certain rights if you default on the lease. Depending on the lease terms and how far behind you are, the lessor isn’t required to assume the lease if the payments weren’t current when you filed bankruptcy.

If you can’t bring the lease payments current in time, you can’t assume the lease in a Chapter 7 bankruptcy. You can return the car to the lender, and you won’t be obligated to pay anything else under the lease agreement. If you’re behind on the payments but still want to keep your leased vehicle, Chapter 13 bankruptcy might be a better choice, depending on your other finances. (More about Chapter 13 below.)

If you don't want to keep the car...

If you don’t want to continue your car lease, Chapter 7 bankruptcy provides a way out. You can simply mark “no” on your Statement of Intention. This is called rejecting the lease. When you reject a lease, you don’t get to keep the car, but you also don’t have to pay any further payments, fees, or charges under the lease contract. 

There are lots of reasons you might not want to continue with your car lease. Maybe your income was higher when you first leased the car, but now you’re struggling to make the payments. Or maybe the car is damaged or has a lot of miles on it, and you don’t want to face huge damage fees or excess mileage charges at the end of the lease. You don’t have to explain your reason for rejecting a car lease in Chapter 7. 

If your Statement of Intention says you’re rejecting the lease, the lessor might file a motion with the bankruptcy court asking to lift the automatic stay so they can pick up the car. Or they might just wait for the automatic stay to expire (30 days after your bankruptcy case was filed). You can usually avoid surprises by contacting the lessor to arrange a pickup or drop-off date and time for the car.

If you’re planning to reject your car lease, you must list the lessor on Schedule F in your bankruptcy forms in addition to filing a Statement of Intention. While the lease itself isn’t a debt, rejecting the lease counts as a default. Under the lease terms, if you default on the lease, you typically owe the remaining lease payment, plus any additional charges, and this counts as an unsecured debt. 

Listing this debt on Schedule F allows you to discharge, or eliminate, the debt in your Chapter 7 bankruptcy. On Schedule F, mark the box next to “unliquidated” for this debt (unliquidated means that the amount you owe hasn’t been calculated yet). For the balance, you can either estimate an amount or write “unknown.”

Car Leases and Chapter 13 Bankruptcy

If you’re filing Chapter 13 bankruptcy, your options are more complicated than in Chapter 7. Like in Chapter 7, if you want to keep your leased car and you’re current on the payments, you can continue making your car lease payment each month. You’ll need to note on your Chapter 13 plan form that you’re paying the lease payments outside the plan. 

If you’re not current on the lease payments but want to keep the car, you can spread the past-due balance out over the entire 3-5 year plan term. Each month, through your Chapter 13 repayment plan, you’ll pay the regular lease payment, plus some portion of the past-due amount. 

Be aware, though, that the bankruptcy judge may not allow you to take this route if it’s not in your financial best interest. The court generally won’t confirm a plan where you pay every month and still end up with no car, though there are exceptions. For example, if the car is reliable and your lease payment is much less than a car loan payment would be or if you’re paying 100% of all your debts through your Chapter 13 plan.

If your lease has an option to buy, it’s usually through a balloon payment. A balloon payment is a large payment owed at the end of the lease. Typically, when you get to the end of the lease, you take out a car loan to pay the balloon payment. The car loan then works just like any other car loan you take out to pay a car’s sales price.

If you file Chapter 13 when you’re close to the end of your lease and the lease has a balloon-payment purchase option, you may be able to pay the entire amount of the balloon payment by spreading the payments over the entire plan term. Again, courts usually won’t allow this unless it’s in your best interest.

Let's Summarize...

Car leases are treated differently in bankruptcy than car loans. This is because a car loan is a debt that’s secured by personal property you own, while a car lease is a contract to use a car someone else owns. In a Chapter 7 bankruptcy, if your lease payments are current, you can continue with the lease as if there was no bankruptcy. Otherwise, you can turn in the car and walk away from any lease-related charges. In a Chapter 13 bankruptcy, you have more options, but the court will usually only approve those that are in your best interest financially.