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Secured Debts, the Focus of Many Bankruptcies

Debts secured by liens on your property or possessions often grab the most attention during a bankruptcy case.

 

“General unsecured” debts, discussed in my last two blog posts, are handled in a relatively straightforward fashion in bankruptcy. In a Chapter 7 case, they are generally discharged (legally written off) without any opposition by the creditors. Those creditors usually get nothing. And in a Chapter 13 case, “general unsecured” debts often are paid simply whatever money is left over, if any, after the secured and priority debts and the trustee and attorney fees are paid. There’s because the creditors usually don’t have much to fight about.

But with secured debts—debts secured by collateral or through some type of lien—your property or possessions that are providing security are often a point of contention.

The next few blog posts will be about how to use Chapter 7 or Chapter 13 to deal with the main kinds of secured debts. Today I start with some important points that apply to most secured debts.

Two Agreements in One

A secured debt effectively involves two interrelated agreements between you and the creditor. First, the creditor agreed to give you money or credit in return for your promise to repay it on certain terms. Second, you gave the creditor certain rights to the collateral, including the ability to take that collateral from you if you don’t comply with the terms of your promise to repay the money.

Generally, bankruptcy will only undo that first agreement—your promise to pay. In contrast, your creditors’ rights to collateral generally survive bankruptcy.

The Value of Collateral

How much the collateral is worth as compared to the amount of the debt becomes very important as to what happens to that collateral.

If the collateral is worth a lot more than the amount of the debt, this debt is considered well-secured. Then there’s a much better chance that the debt would be paid in full.  You’ll really want to pay off the relatively small debt to get the relatively expensive collateral free and clear of that debt. Or if you didn’t make the payments the creditor will get the collateral and sell it for at least as much as the debt.

If the collateral is worth less than the amount of the debt, the debt is considered undersecured. It’s less likely that such a debt would be paid in full because in return you’d get collateral worth less than what you’re paying.

Depreciation of Collateral, and Interest

Since the value of the collateral is such an important consideration for a secured creditor to be made whole, the loss of its value through depreciation is something that creditors care about, and about which the bankruptcy court respects.

Also, in most situations secured creditors are entitled to interest. So, you’ll see in our next blog posts that when there are conflicts with secured creditors—on home mortgages or vehicle loans, for example—issues about depreciation and interest become important.

Insurance

Virtually every agreement with a secured creditor—definitely those involving vehicles and homes—requires that you carry insurance on the collateral. If the collateral is damaged or destroyed, this insurance usually pays the debt on the collateral before it pays you anything. And, if you don’t get the required insurance, the creditor itself can buy insurance to protect only its interest in the collateral AND charge you for it.

 

With these points in mind, the next blog post will tell you your options with your vehicle loan under Chapter 7.

 

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Qualify for a Vehicle Loan “Cramdown” by Filing Your Chapter 13 Case at the Right Time

Potentially save thousands of dollars on your vehicle loan by filing bankruptcy when it qualifies for cramdown.


This is the final one of a series of four blog posts on the advantages of filing bankruptcy at the legally opportune time. The last three blogs covered the effect of timing on whether you file a Chapter 7 or Chapter 13 case, on which debts can be discharged, and on what assets you can keep. Today’s applies only to Chapter 13 “adjustment of debts” cases, because vehicle loan cramdowns cannot be done under Chapter 7 “straight bankruptcy.”

Chapter 13 Vehicle Loan Cramdown

What’s a “cramdown”? It’s an informal term—not found in the federal Bankruptcy Code—for a procedure provided under Chapter 13 law for legally rewriting the loan to reduce, usually, both the monthly payment and the total you pay for the vehicle. A cramdown, essentially reduces the amount you must pay to the fair market value of your vehicle, often also reducing the interest rate, and also often stretching out the payments over a longer period. These combine to result often in a significantly reduced monthly payment, and an overall savings of thousands of dollars.

Qualifying for Cramdown

First, this only works if your vehicle is worth less than the balance on the loan.

Second, emphasizing again, it is ONLY available in a Chapter 13 case, not Chapter 7.

And third, your vehicle loan must have been entered into more than 910 days (slightly less than two and a half years) before your Chapter 13 case is filed.

Vehicle Cramdown

It’s of course that last condition that creates the timing opportunity. When you first go in to see your attorney, bring your loan vehicle paperwork (or as much information you have) to see if and when you qualify for cramdown, and whether and how much difference it can make for you.

Here’s an example of the dollar difference that a difference in timing can make.

How Good Timing Can Work for You

Let’s say you bought and financed your car 900 days ago—that’s almost two and a half years. The new car cost $21,500. You did not get a very good deal; your previous car had died and cost way too much to repaid, and you had to quickly get another car to commute to work. You put down $500 (from a credit card cash advance), then financed the vehicle for $21,000 at 8% over a term of 5 years, with monthly payments of $425.

Now almost two and a half years later you owe about $11,500. If you wanted to keep the car, and filed either a Chapter 7 or Chapter 13 case before the 910-day mark, you would have to pay the regular monthly payments for the rest of the contract term. With interest, that would cost a total of about $12,650 more.

Consider if instead you waited until just past that 910-day mark and filed a Chapter 13 case then, and could “cram down” the car loan. Assume that your car is now worth $7,500, and again you owe $11,500. The loan is said to be secured to the extent of $7,500. The remaining $4,000 of the loan is not secured by anything. So the $7,500 secured portion would be paid through monthly payments in your Chapter 13 plan. The $4,000 unsecured portion is treated like the rest of your unsecured debts, which are usually paid if and only to the extent that you have extra money available to pay them.

Under cramdown, you pay the $7,500 secured portion at an interest rate which is often lower than your contract rate. Paying a reduced amount—$7,500 instead of $11,500—at a lower interest rate results in a lower monthly payment. That payment is often reduced substantially further by extending the repayment term further out than what the contract had provided, up to a maximum of five years (from the date of filing the Chapter 13 case).

In this example, assuming an interest rate of 5% and a repayment term of five years, the payment on the $7,500 would be less than $142 per month. The total remaining payments on the loan, with interest, would be about $8,492, in contrast to paying $12,650 under the contract. That is a savings of $4,158.

Note that under cramdown, even though the repayment term stretches the payments about two and a half years longer than under the contract, the amount of interest to be paid is often less. That’s both because the interest rate is often lower, and it’s being applied to a lower principal amount (here 5% interest instead of 8%, and $7,500 instead of $11,500).

So, by tactically holding off from filing a Chapter 13 case until after the 910-day period expires, in this example you would reduce the monthly payment from $425 to $141.50, and save more than $4,000 before owning the vehicle free and clear. 

 

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