Bankruptcy by Example: Paying Less for Your Vehicle through “Cramdown”

Through Chapter 13 you may be able to lower your vehicle payments AND pay less than what you owe but still end up owning it free and clear.

The Often Inadequate Chapter 7 Solution for a Vehicle Loan

In a Chapter 7 “straight bankruptcy” case, if you are not current on your vehicle payments almost always you need to get current within a month or two of filing your case or else you won’t be able to keep your vehicle.

And what if the monthly payments on the vehicle loan are more than you can afford, or if the vehicle is worth much less than the amount you owe?

Or what if you have some other special debts that aren’t going to be discharged (written off) in the Chapter 7 case—like recent income taxes or back child support, debts that must be paid quickly, so that you just aren’t going to have enough money to catch up quickly on your vehicle loan arrearage? Or you won’t have enough to pay your full monthly vehicle payment?

The Chapter 7 answer is: too bad. If you want to keep the car you usually have to get current quickly. And you almost always must “reaffirm” the debt—exclude the debt from the bankruptcy discharge—putting you at risk for owing a lot if the vehicle is ever repossessed later.

The Chapter 13 “Cramdown” Solution

All of these serious problems can be solved if your vehicle loan qualifies for a “cramdown” in a Chapter 13 case. If so, you would not have to catch up on any late payments at all. The vehicle loan’s monthly payment would likely be reduced—often significantly—along with the total amount you would pay for the vehicle.

Here’s how “cramdown” works.

The Example

Paul and Karen, married, in their mid-30s, have two vehicles. One is free and clear, having been paid off recently. Their second vehicle, driven mostly by Karen, was bought new four years ago after they were married. Their jobs are located in opposite directions from their home, often have irregular and incompatible work hours, and there is no public transportation, so they need both vehicles.

Their income has very recently become stable, but because of gaps in employment during the last couple years and Paul’s period of self-employment, they’ve have for the last several years not been able to keep current on their debts, including starting last month on Karen’s car.

Between the two of them, they owe:

• $31,000 in “general unsecured” debts—credit cards, medical bills, two payday loans:

The credit card payments were all late at some point, so that their interest rates are sky-high, the accounts mostly maxed out and some over the limits. The medical bills have all been sent to collections, with threats of lawsuits. One payday loan creditor just filed a small claims suit against them.

• $7,500 in 2011 and 2012 joint federal income taxes and accrued interest/penalties:

This is directly related to Paul’s short-lived effort at self-employment. He didn’t pay quarterly estimated taxes because there just wasn’t enough money for that while trying to keep up on everything else, especially the vehicle payments. Interest and penalties on the taxes are piling up. The IRS is requiring them to start making payments, but they just don’t have the money. And they know they’ll have even less money soon: the payday loan lawsuit means that their wages are soon going to be garnished, because that creditor of course knows exactly where they work.

• $9,500 on the vehicle loan:

Karen’s car loan has regular monthly payments of $451, at 9% interest, with 23 more months to pay on it. After 4 years, the vehicle is now worth about $5,800. They are about to be two months behind ($902) on that car, and simply do not have that money.

Paul and Karen make only enough to pay their necessary living expenses plus about $500. That’s it. So they see absolutely no way that they can hang onto Karen’s car, pay the back taxes, solve the pending lawsuit, and deal all their other creditors. Their situation is getting worse by the day, and they are scared.

Salvation by “Cramdown”

Paul and Karen go to an experienced bankruptcy attorney. They discover that with a Chapter 13 “cramdown” of the vehicle loan, they can keep the car without having to pay the $902 in back payments, they can reduce the interest rate, the monthly payments, AND the total to be paid on the that loan.

They also learn that they can pay off the taxes without paying any further interest and penalties, and without the threat of the IRS garnishing their wages or bank accounts. They further learn that they can get rid of most of their other debts as well.

ALL of this can be done by paying $500 per month for the next 36 months. At the end of that time they would own Karen’s vehicle free-and-clear, would owe no income taxes, and otherwise be totally debt-free.

How Could All of this Be Done for $500 per Month?

Their 4-year old vehicle loan qualifies for “cramdown” because it is at least 910 days (about 2 and half years) old. “Cramdown” is in effect a rewrite of the $9,500 loan, dividing it into secured and unsecured parts. The secured portion, $5,800, based on the current value of the vehicle, they must pay in full, but with lower monthly payments and a lower interest rate. The unsecured portion, the remaining $3,700, they pay only to the same extent that their other unsecured creditors are being paid, which is often not very much.

Assuming that the interest rate would be reduced from 9% to 5%, to pay off the $5,800 secured portion over 36 months would cost only about $180 per month. That’s a big monthly savings compared to the $451 regular payment.

The Rest of the Chapter 13 Plan

A $500 monthly Chapter 13 plan payment, $180 of which is going to pay the secured portion of the vehicle loan, leaves $320 per month—over the course of 36 months—to pay the taxes and the rest, or $11,520 beyond the car payment. With $7,500 of that going to pay off the income taxes (with no additional interest and penalties), that leaves $4,020. Most of that would likely go to the Chapter 13 trustee’s fees (usually between about 5% to 10% of the total dollars paid into the plan) plus your attorney’s fees (to the extent those were not paid up front). This would leave little or possibly even nothing for the unsecured debts—whatever amount of money would be left would be divided pro rata among those debts, including the unsecured part of the vehicle loan.

In the End . . .

Paul and Karen start from what seems like a totally hopeless situation—the car that Karen absolutely needs for work is about to be repossessed, their wages about to be garnished, no ability to pay an increasing tax debt, and no clue about how to begin to deal with their other debts. Chapter 13, and especially the vehicle loan “cramdown,” provides the solution to all these problems.

They pay hundreds of dollars less each month and thousands of dollars less overall on their car while keeping it, pay less on their taxes while paying it off without pressure, and pay tens of thousands of dollars less on their other debts while being protected from the present and any future lawsuits. They avoid repossession, garnishment, and IRS tax collection, and become totally debt-free in three years.