If your vehicle is worth less than you owe, Chapter 13 “cramdown” can reduce your monthly vehicle payment and the total you pay on the loan.
You could get a fresh start on your vehicle loan by:
- Paying a smaller monthly payment immediately
- Reducing the interest rate
- Not needing to catch up on payments if you’re behind
- Reducing the total amount you pay before the vehicle is yours free and clear
If you owe on your vehicle loan more than your vehicle is worth, and your loan is more than 910 days old (about 2 and a half years), you can very likely do some or all of the above through a Chapter 13 “cramdown” of the vehicle loan.
The Chapter 7 Vehicle Loan Dilemma
In the last two blog posts we described how to keep your vehicle under a Chapter 7 “straight bankruptcy” case through either “reaffirming” the vehicle loan or “redeeming” it. Both can cause problems.
With reaffirmation you agree to continue being legally liable on the full amount of the loan. The reaffirmation agreement excludes the vehicle loan from the discharge (legal write-off) of the debt, giving back to your vehicle lender all the rights it has under the loan.
This can cause problems because of the risk that sometime in the future you would not be able to make the loan payments. If so the lender would have the right to repossess the vehicle. And then the lender could come after you for the “deficiency balance”—the amount that you would usually continue to owe after the lender sells the repossessed vehicle and credits the proceeds to the balance. In most situations if you want to keep the vehicle you must sign on to a reaffirmation agreement. And so you are stuck with these risks.
With redemption you get out from the entire vehicle loan by paying the current fair market value of the vehicle in a lump sum, assuming that value is less than the balance on the loan. You get the money for this fair market value either through your own assets, by begging or borrowing it from friends or relatives, or by borrowing from commercial sources which do these kinds of special loans.
But often none of these ways of getting the money for the vehicle’s fair market value are feasible. You may simply not have any assets that you can turn into the required amount of cash, or the friends or relatives willing to give or lend you the money. And you may not qualify for a redemption loan.
So what do you do if you have a vehicle worth significantly less than you owe on it? What if you don’t want to reaffirm, risk losing it to repossession and then being sued for the deficiency balance? What if you can’t redeem because you can’t get the money to do so?
You may well be able to get a fresh start on this vehicle loan by filing a Chapter 13 “adjustment of debts” and doing a “cramdown” on that loan.
Cramdown Divides the Vehicle Loan into Secured and Unsecured Portions
Under a Chapter 13 payment plan secured debts and unsecured debts are treated quite differently. In general, secured debts need to be paid in full if you want to keep the collateral (or at least paid current in the case of long term debt like a home mortgage). Unsecured debts in most cases only need to be paid if and to the extent that there is money left over during the 3 to 5 year term of the case after other more important debts are paid.
So a vehicle loan in which the vehicle is worth less than the balance is divided into two parts: the secured portion of the loan and the unsecured portion. The amount of the secured portion is determined by the value of the vehicle. The amount of the unsecured portion is the rest of the loan balance, the part that effectively has no collateral.
For example, if you still owe $16,500 on a 3-year old vehicle loan and the fair market value of your vehicle is $10,500, then the secured portion of that vehicle loan is $10,500 and the unsecured portion is $6,000.
Recalculation of Number of Payments, Interest Rate, and Amount of Payments
Cramdown allows the payment terms of the loan to be rewritten based on the secured portion of the debt only. Because that’s less than the full loan balance, the new monthly payments are usually less, sometimes hugely so.
In the above example, the new monthly payments are based not on the $16,500 full balance but rather on the $10,500 secured portion.
The number of monthly payments can often be stretched out, up to 60 months. How much this helps in reducing the monthly payment depends in part on how many months were left on the contract at the time of the bankruptcy filing—in other words how much more the payments can be stretched out.
For example, if you’re 3 years into a 6-year vehicle loan when you file a Chaper13 case, you can usually stretch that remaining 3 years out over 5 years if you need to.
Of course more interest accrues if a debt takes longer to pay. But remember that the amount being paid—the secured amount—is less, which lessens the interest accrual. Plus, cramdown sometimes allows the interest rate to be lowered, especially if the contract interest rate is high. For example, depending on how your local bankruptcy judges are ruling on this issue, you may be able to reduce a 9% interest rate to about 5%.
The example we’ve been can illustrate the kind of reduction you can get in the monthly payments (although there may be need for some negotiation with the lender’s attorney to get at the final figures). The contract balance of $16,500 paid over the remaining 36 months of the 9% vehicle loan would require a monthly payment of about $525. But under Chapter 13 cramdown, paying the secured amount of $10,500 over the maximum 60 months of a payment plan at 5% would require a monthly payment of only about $198.
(Note that in this cramdown example the total interest paid over the term of payments is significantly less than under the contract—about $1,400 instead of about $2,400. This is true because of the lower principal amount being paid off combined with the lower interest rate, even though the monthly payments are much lower and are being stretched over a much longer period—60 months instead of 36.
The Unsecured Portion of the Vehicle Loan
That’s fine and well as to the savings on the secured portion of the loan but how about the remaining unsecured portion? In our example, what about the remaining $6,000?
This remaining unsecured portion is treated just like your other “general unsecured” debts. Some very special unsecured debts—such as recent income taxes and child support arrearage—called “priority” debts, have to be paid in full during the life of a Chapter 13 plan. But not “general unsecured” debts. In most cases these debts are paid only as much as there is money in your budget to pay them, if anything. In other words the percentage paid on the “general unsecured” debts is usually based on the amount you can afford to pay during the period of time you are in the Chapter 13 case AFTER paying the “priority” and secured debts. Although that percentage can conceivably be anywhere from 0% to 100%, it’s often on the lower end of that range.
Also note that usually you pay a certain total amount to your pool of “general unsecured” debts over the life of your Chapter 13 case. Therefore, adding the unsecured portion of your vehicle loan to that pool usually does NOT increase the amount you have to pay into your Chapter 13 plan. It rather just spreads that amount out among more “general unsecured” debts. Under these circumstances, for practical purposes the unsecured portion of your vehicle loan is not costing you anything.
Using our example with the $6,000 unsecured portion of the vehicle loan, assume that person had $25,000 of other “general unsecured” debts and that a total of $5,000 would be available to be paid his or her “general unsecured” debts over the entire life of the Chapter 13 case. Without the $6,000 unsecured portion of the vehicle loan, the other “general unsecured” debts would receive $5,000 out of the $25,000 owed, or about 20%. But adding in the $6,000 from the vehicle loan makes for a total of $31,000 in “general unsecured” debts. Now the same $5,000 distributed among the $31,000 would result in the “general unsecured” debts instead receiving about 16%, without it costing a penny more to the debtor.