Making Sense of Bankruptcy: The Vehicle Loan “Cramdown”
April 22, 2015
Chapter 13 may allow you to significantly reduce your monthly vehicle payment and to pay off the debt for thousands of dollars less.
In this “Making Sense” series, we’re helping you understand bankruptcy by explaining its main concepts within single sentences.
Today’s sentence: A cramdown can be done with negative equity vehicle loans more than 910 days old, with amount of your monthly and total savings depending on your circumstances.
Cramdown makes sense if you start with the reality that Chapter 13—the 3-to-5-year partial payment plan—allows you to treat your secured debts (those with collateral) and unsecured debts differently. Indeed you are required to treat them differently.
With secured debts, if you want to keep the collateral you must pay the debt. With most unsecured debts, you usually only have to pay them to the extent you can afford to pay them during the period that the Chapter 13 case lasts. Often secured debts get paid in full while unsecured debts get little or even nothing.
But what if an otherwise secured debt has collateral that’s not worth as much as the amount of the debt? Then that debt is only partially secured, it’s secured up to the value of the collateral. For example, a vehicle loan with a balance of $10,000 on a vehicle worth $7,000 is a secured debt in the amount of $7,000, and is an unsecured debt as to the remaining $3,000.
Cramdown simply allows you to divide that vehicle loan into its secured and unsecured parts, and pay each accordingly. You essentially “cram down” the vehicle loan to the value of the vehicle. Rewriting the loan based mostly on the secured part of the debt usually allows you to reduce the monthly payment and to reduce the amount you pay overall for your vehicle before it is yours free and clear.
Dividing a vehicle loan into its secured and unsecured parts is only helpful to you if the vehicle’s value is less than the amount of the debt. The cramdown advantage comes from not paying the unsecured part in full. So if the vehicle is worth the amount of the debt or more, then the debt is fully secured and there is no unsecured part of that debt, and no cramdown to be done.
The more the vehicle is worth less than the amount of the debt, the more cramdown can help you.
More than 910 Day Old Contract
Congress decided that this cramdown advantage should only be allowed on vehicle contracts that were more than 910 days old, which is about two and a half years. There was no such condition in the law earlier, but it was added in to prevent people from doing cramdowns on relatively new vehicle loans. With new vehicles there is usually a steep drop-off in value during the first few months and years after a purchase, and apparently Congress believed that debtors should not be able to take advantage of that initial depreciation.
Reduced Monthly Payment
The amount of your new monthly payment depends on how much your vehicle is worth, its new interest rate, and how long you will be paying that new amount.
The value of your vehicle—the secured part of the debt—determines what in effect becomes the new principal amount of the loan. As mentioned above, the lower the value compared to the vehicle loan amount, the more the likely reduction in what you would pay through cramdown. As in the above example of the $10,000 vehicle loan, the new amount to be paid would instead be $7,000.
You may be able to reduce your interest rate on the loan going forward, depending on your contract interest rate and on how your local bankruptcy court is interpreting the law about reducing that rate in your situation. A reduced interest rate could reduce the monthly payment (as well as the total amount to be paid).
With a reduced amount of principle to pay, and likely a reduced interest rate, your monthly payment is also affected by how long you have before paying off the secured amount. Often you can stretch the payments out over a longer period, reducing the monthly payment that much more. Although extending the payments over a longer period may add more interest to pay, that is often counteracted by a lower interest rate and the fact that you are paying interest on a lower principle amount. The lower monthly payment itself also often makes extending the payments worthwhile.
Your total savings on a vehicle cramdown depends on how much you pay on both the secured and unsecured parts of the vehicle loan before you own the vehicle free and clear of the loan, compared to what the loan would have cost you otherwise.
The amount you would pay on the secured part we just discussed: the new principle based on the value of the vehicle, paid at usually a lower interest rate, and paid over a period of time that is often longer than it would be otherwise.
The amount you pay on the unsecured part is the same percentage that you would pay to your other “general unsecured” debts. That percentage is usually based on the amount you can afford to pay them during the period of time you are in the Chapter 13 case AFTER paying the “priority” debts (recent income taxes, back child and spousal support, etc.) and secured debts. That percentage can be anywhere from 0% to 100%, and is often on the lower end of that range. Also realize that because usually you only have a certain amount that you would be paying into the pool of all the general unsecured debts, adding the unsecured part of the vehicle loan to that pool usually doesn’t increase the amount you have to pay into your Chapter 13 plan. It rather just reduces what the other general unsecured debts would be paid.
The Sentence Translated
The sentence we started with is:
A cramdown can be done with negative equity vehicle loans more than 910 days old, with amount of your monthly and total savings depending on your circumstances.
The translation is:
Chapter 13 allows you to divide your vehicle loan into its secured and unsecured parts and to pay them differently, but only IF you owe more than the vehicle is worth and you financed the vehicle more than two and a half years ago. The amount of your new (usually lower) monthly payment depends on how much your vehicle is worth, its (likely lower) interest rate, and how long you will be paying that new amount. Your total savings depends on those factors, plus on what percentage of your unsecured debt you are paying, if any.