So, this is basically mandatory partial insurance on loans? Economically this means (assuming your proposal is revenue-neutral for banks) forced wealth transfer from borrowers who were able to pay off the loans to borrowers who were not able to.

I don't think it's a terribad idea which will doom the Western civilization, but I don't think it's much good, either. You're effectively setting up a "bankruptcy lite" regime where you still have to go to court and show that you're destitute ("unable to pay", so presumably you have no cash and nothing in your bank accounts), but if the court decides it was not your fault, you get to keep some of your assets. Meh.

You'll also get a bunch of unintended consequences, as usual. Off the top of my head here are two:

• If there is a significant chance the loan will be forgiven if the debtor has no money, banks will start to take credit scores seriously. People with a healthy bank account will be given loans, people who live paycheck to paycheck will be denied loans or charged exorbitant rates. There is no right to credit, and no right to low rates either. Make it too easy to default on a loan and the banks will react by just not giving loans to people likely to default.

• Specifically with respect to auto loans, if there is a chance you won't be able to get your collateral (the car) back, the banks will have incentives to find other ways to finance. For example, you can structure a lease with an option to buy at the end to be much like a car loan: make the monthly payments larger, make the residual value smaller, and it's quite similar. But the crucial difference is that you can always repossess the leased car. Therefore under your proposed regime, leases will become more frequent.