A bill pending in the U.S. Senate Judiciary Committee is striking fear in the heart of Steven Pittler, who lends to auto buyers with spotty credit.

The legislation, called the Consumer Credit Fairness Act, carries serious consequences for auto-finance lenders such as Pittler. If passed into law, the bill would also hit the market for used cars, whose values took a battering last year from high gas prices.

The bill would allow borrowers to avoid payments on expensive consumer debt, including auto loans, when they file for bankruptcy protection. It would also eliminate lenders' ability to reclaim vehicles as collateral to cut losses.

The bill faces a steep climb in the Senate, which recently rejected a measure to allow strapped homeowners to reduce their mortgages in bankruptcy.

Legislators supporting the bill argue it is a necessary check on unfair lending practices and would ease the debt burden on strapped Americans. The bill "is intended to help consumers struggling under the burden of high-interest debt by encouraging lenders, including auto sellers, to keep interest rates low," said Alex Swartsel, a spokeswoman for Sen. Sheldon Whitehouse, D-R.I., who with Sen. Dick Durbin, D-Ill., are the bill's co-authors. "Laws on retaining property in bankruptcy estates vary from state to state, but in general, the bill will make it easier for people entering bankruptcy with high-interest debt to keep their cars."

The bill would deal a blow to lenders such as GMAC LLC and Ford Motor Credit, whcih provide crucial financing to car buyers of the domestic struggling auto makers. For General Motors Corp. (GM), Ford Motor Co. (F) and Chrysler LLC and their financiers, this would come on top of steep declines in sales and higher delinquencies on auto loans.

"The pendulum is swinging too far on the other side," says Pittler, president at Friendly Finance Corp., a private auto-finance company that lends to subprime, or less credit-worthy, consumers in 10 states.

The bill is aimed at voiding contracts for costly debt in bankruptcy filings. It defines this high interest rate at 15% plus the yield on a 30-year Treasury bond (currently this adds up to a little over 19%).

Interest rates can be around these levels on auto loans to subprime borrowers, including such loans for used cars. The bill essentially means that an auto loan carrying these rates will be voided if the borrower files for bankruptcy protection.

The critics of the bill warn that the legislation would restrict credit at a time when Americans need it most. The lenders defend the business practices as necessary to protect themselves when providing money to consumers with patchy credit.

If the bill is passed, "it's hugely significant," says Michael Benoit, a partner at Hudson Cook LLP. It would leave the auto-finance lender "holding the bag. In the short term at the least, there will be contraction of credit at a time when we really can't afford that."

A reluctance to lend to subprime borrowers will shut out a large swath of potential car buyers. In November, GM said nearly three-fourths of customers had a credit score below 700. The median credit score for U.S. consumers is about 723. Different lenders define subprime borrowers differently; typically, these consumers have credit scores of 620 and lower.

If the bill is passed, lenders would no longer be able to cut their losses by reclaiming the vehicles of borrowers who have defaulted on their payments and filed for bankruptcy.

"As a lender, not only do I lose my claim against the borrower, I can't repossess the vehicle," says Bill Himpler, executive vice president of federal affairs for American Financial Services Association, an industry lobby group.

A spokeswoman at Ford Credit declined to comment. A GMAC spokeswoman wasn't available for comment.

Friendly Finance's Pittler estimates a loss of about $7,000 for every repossessed vehicle that is then sold off in an auction.

"You can imagine the losses the lender would incur if he can't reduce the borrower's balance by selling the repossessed car," says Pittler. "This bill encourages people to file for bankruptcy; essentially they get rewarded with a free car."

-By Aparajita Saha-Bubna, Dow Jones Newswires; 617-654-6729; aparajita.saha-bubna@dowjones.com

(Jessica Holzer contributed to this report.)