If your vehicle is worth less than you owe, or you are paying excessive interest, cramming down a car loan in Chapter 13 bankruptcy can reduce your balance, cut your interest rate, and slash your payment. A “cramdown” of an auto loan is a major benefit available in Chapter 13 that is not available in Chapter 7 bankruptcy.
Bad car loans can be devastating financially. As a bankruptcy attorney in Philadelphia, I have seen clients with auto loans more than two times the value of their vehicles and at exorbitant interest rates. Also, the egregious credit union practice of cross-collateralization (see below) leaves many consumers with liens far above the value of their vehicles. However, it is not only debtors with bad loans who benefit from Chapter 13 cramdowns. Unexpected depreciation of a vehicle’s value and a modestly high-interest rate will quickly place almost anyone underwater on a car loan.
Cramming Down the Balance on an Auto Loan
Cramming down your car loan balance in Chapter 13 reduces the balance to the vehicle’s fair market value. You pay the new lower amount in 36 to 60 months through your Chapter 13 plan. Although a creditor may object to the value that you propose, courts will generally accept the average Bluebook or NADA value. Any remaining balance becomes an unsecured debt like your credit cards, medical bills, etc. Because many Chapter 13 debtors pay only a small portion of their unsecured debt (often cents on the dollar), cramming down the balance can save you thousands of dollars.
Example: Kim has a car worth $12,500, but the balance on her auto loan is $18,500. Her payment is $511 per month at 6% interest. In Chapter 13, Kim can cram down the balance to $12,500. Therefore, her payments would be based upon this new lower balance. The remaining $6000 becomes an unsecured debt, which will most likely be paid back at cents on the dollar. Kim’s payments will be reduced to $241 per month when paid through a 60-month Chapter 13 plan.
Cramming Down the Interest Rate on an Auto Loan
The bankruptcy code also allows debtors to cram down the interest rate on a vehicle loan. Here in the Eastern District of Pennsylvania, a rate of one or two points over prime is standard. The current prime rate (as of the date of this post) is 3.25%. Therefore, the court will allow a cram down of the interest rate in the range of 4.25% to 5.25%. If you are paying a high-interest rate, even a drop of a few points can make a significant difference.
Example: Karl is paying 10% interest on his car loan and has a balance of $7500. His current car payment is $369 per month, and he has 24 months left on the loan. If Karl crams down his car loan to one point above prime, he will pay 4.25% interest on his loan, saving him 5.75 percentage points on his interest rate. In a 60-month Chapter 13 plan, Karl’s payment drops to $139.
Quick Note: A debtor filing under Chapter 13 can cram down the balance and interest rate on any secured loan, except for mortgage loans on the debtor’s primary residence. Thus, the same principals apply to loans for cars, trucks, boats, refrigerators, computers, and any other secured property. Also, the Bankruptcy Code allows debtors to cram down and strip the lien on a second mortgage that is not secured by equity in the home. Mortgages on rental property are also subject to cramdown.
The 910-Day Rule
To be eligible to cram down the balance on an auto loan, you must have purchased the vehicle at least 910 days (a little over 30 months or 2.5 years) from the date that you filed your Chapter 13 bankruptcy. The 910-day rule also applies to cramming down interest rates.
Quick Note: Auto lenders will sometimes accept a reduction in the interest rate on a vehicle that was purchased closer than 910 days to the filing date, even when they are under no obligation to do so.
Stretching Out Payments on an Auto Loan
Another advantage of Chapter 13 bankruptcy is that you can stretch out your payments over the course of your 36 to 60-month plan, regardless of whether you are eligible for a cramdown. For example, if you have 36 months left on your auto loan, by placing it in a 60-month Chapter 13 plan, you can spread your loan out over 24 more months and significantly reduce the payment.
Quick Note: Chapter 13 can also help you catch up on your payments if you are behind on your car loan. However, a cramdown is available even if you are current with your payments.
The Power of Three
When you combine a cramdown of the balance, a cramdown of the interest rate, and the ability to stretch your payments out over the life of your Chapter 13 plan, the savings can be substantial.
Example: Mark’s car is worth $11,000, but he has a loan balance of $15,000 at an interest rate of 9%. Mark’s payments are $477, and he has 36 months left on the loan. Mark files for Chapter 13 bankruptcy and proposes a 60-month payment plan. If Mark crams down the balance on the loan to the fair market value of $15,000 and crams down the interest rate to 4.5%, his new car payment will be $205.
Thus, a Chapter 13 cramdown can not only save your car but also save you thousands of dollars. Also, keep in mind that you can also use Chapter 13 to catch up on missed payments.
Making the Cramdown Permanent. You must complete your Chapter 13 plan to make the cramdown of the balance an interest rate permanent. If you do not complete your Chapter 13 plan, the original balance and interest rate may be restored and back interest added to the balance.
Common Situations Impacting Cramdown
Non-filing Co-Debtors. Generally, if you have a co-debtor on a vehicle loan who is not in bankruptcy, it is not practical to cramdown an auto loan. This situation is common when a husband and wife took out the auto loan together, and only the husband or the wife files for Chapter 13 bankruptcy. In such cases, the creditor may object to the cramdown or possibly seek compensation or repossession after the bankruptcy is over. That being said, it is sometimes possible to obtain a creditor’s agreement to the cramdown, if the alternative is Chapter 7 for both debtors.
Cross-Collateralized Vehicle Loans. A Chapter 13 cramdown can be useful in dealing with cross-collateralization provisions, particularly in credit union loans. In the case of auto loans, cross-collateralization agreements allow the credit union to use your automobile as collateral for all subsequent credit issued to you by the credit union.
Example: Marie takes out a car loan with Big Credit Union. She has been making payments on time but still owes $5,000. (The car is worth about $10,000.) Big Credit Union has cross-collateralization provisions in all of its auto loans. Marie later takes out a $5000 personal loan from Big Credit Union and opens a Big Credit Union credit card, which has a balance of $10,000. Although Marie owes only $10,000 on her car loan, her car is now collateral for the $10,000 she owes on the credit card and the $5000 personal loan. In other words, rather than owing $5,000 on her car, she now owes $20,000 ($5000 car loan + $10,000 credit card + $5000 personal loan = $20,000). Moreover, if she misses a credit card or loan payment, the credit union could repossess her car.
Fortunately, a debtor can cram down the debt to the fair market value of the car. Thus, in the example above, Marie’s debt on the vehicle loan and subsequent debts would be reduced to $10,000, and the credit union would no longer have a lien on the vehicle for the remaining $10,000 in debt. The remaining debt becomes general unsecured debt and would be paid the same percentage as credit cards and other unsecured debts.
Chapter 7 Alternatives to Cramdown
Redemption. In Chapter 7 bankruptcy (not Chapter 13), it is possible to pay the fair market value of the vehicle secured by a car loan in a lump sum. The creditor may challenge the debtor’s valuation of the car, but most courts will look at the Kelley Bluebook or NADA value, or sometimes comparable items listed for sale. Of course, coming up with the cash to redeem personal property can be difficult. Most often, the debtor uses exempt assets or contributions from family or friends to pay the redemption amount. Redemption financing is sometimes available as well.
Example: Harvey owns a vehicle with a bluebook value of $5000. The balance on his vehicle loan is $10,000. Harry files for Chapter 7 bankruptcy. Harvey can redeem the vehicle by paying the creditor $5000. The remaining $5000 is discharged.
Reaffirming the Vehicle Loan In Chapter 7. A reaffirmation agreement is an agreement with a creditor whereby a debtor agrees to pay the debt as if he or she had not filed for bankruptcy. Sometimes creditors will agree to better terms as an incentive for the debtor to sign the agreement. However, in most instances, reaffirmation agreements are a bad deal, as they lock the debtor into the loan and make the debtor subject to a deficiency judgment and negative credit reporting, should the debtor fall behind on payments.
Often, the best course is to continue to make payments and keep the vehicle. Most vehicle lenders will allow a debtor to keep a vehicle, as long as the debtor continues to make the payments. (A few creditors require reaffirmation agreements if the debtor wishes to keep the car after Chapter 7, but most do not.) This gives the debtor the option of merely surrendering the car without risk of a deficiency judgment, should the debtor run into financial problems in the future.