You’ve been diligently paying your monthly car payment for a few years, and now your car is worth less than what you owe on it. It hardly seems fair, but is actually very common, especially for those borrowers who took out a five- or six-year car loan.
Here is some good news. You can lower that monthly car payment by filing Chapter 13 bankruptcy, and eliminate other debt too when you receive a Chapter 13 discharge. Here’s how.
What is Chapter 13 Bankruptcy?
When a debtor files bankruptcy under Chapter 13 of the federal Bankruptcy Code, he or she discloses all income, assets, debt, and expenses, and also files a Chapter 13 plan proposing to pay creditors in part or wholly, over three or five years. Whatever unsecured debt remains unpaid at the conclusion of the plan is discharged, meaning, the debtor is no longer personally responsible for paying it.
The court must approve or “confirm” the debtor’s proposed Chapter 13 plan. The debtor makes payments each month to the Chapter 13 Trustee, who in turn pays the creditors listed in the plan.
People commonly file bankruptcy under Chapter 13 when:
- They make too much income to qualify for chapter 7 bankruptcy liquidation, and must pay their creditors in part through their plan;
- They are in arrears with a mortgage, car loan, alimony, child support, or government fines, fees, or taxes;
- They want to “strip off” a second mortgage as unsecured because their home is worth less than the amount owed on the first mortgage;
- They want to “cram down” their car because their car is worth less than the loan balance.
What is Chapter 13 Cram Down?
“Cramdown” is the term used to describe the process by which a Chapter 13 debtor forces the car lender to accept less than the loan balance in exchange for the title to the car.
How does this work? Chapter 13 debtor and his or her attorney must first come up with a retail value of the car as of the date of filing bankruptcy. Taking into consideration the condition of the car and mileage, they will consult the NADA Guide or Kelley Blue Book and list the current retail value of the car in the proposed Chapter 13 plan, as well as the proposed applicable rate of interest (prime plus 1-3%).
The lender then gets notice that the debtor is cramming down the car to retail value and has the opportunity to object if they disagree as to the debtor’s valuation or the debtor’s proposed rate of interest. If the lender does object, the debtor’s plan cannot be confirmed unless that objection is resolved. Most often, the debtor’s attorney will negotiate a compromise. However, if a compromise cannot be reached, there will be a hearing before the bankruptcy judge and the judge will decide.
However the value is determined, once the plan is approved, the car lender must accept the reduced monthly payments from the Trustee, and at the conclusion of the debtor’s plan, the debtor owns the car free and clear.
What if My Car is Worth the Loan Balance?
You can still cram down the rate of interest to prime plus 1-3%, and lower your monthly payments by stretching them out over three or five years. Win! Plus you can get unsecured debt like credit card balances and medical bills discharged.
What if I Can No Longer Afford this Car?
If Chapter 13 won’t make your payments more affordable for you, then you can surrender the car to the lender. The lender then auctions it off and applies the auction proceeds to your account. There will likely be a deficiency balance on your account, meaning that the car sold for less than your loan balance, but the deficiency balance is discharged as unsecured so you do not have to pay it.
You can surrender your car and be discharged of any deficiency balance in either Chapter 13 or Chapter 7. When you file bankruptcy, you have the power to just walk away from a car you can’t afford.
What if I Have a Lease?
Leases can also be treated in Chapter 13. If you are behind on your lease, you can use your Chapter 13 plan to catch up, however, you will also have to keep making your regular monthly lease payments directly to the lessor.
If you are reaching the end of your lease term, and you want to buy the car, you can pay that balloon payment over time through your three- or five-year Chapter 13 plan, at an interest rate of prime plus 1-3%.
If you are having trouble making your car loan or lease payments and are considering filing bankruptcy, consult a bankruptcy attorney sooner rather than later, to save your credit rating from taking a hit from missing payments or car repossession.
About the Author
Veronica Baxter is a legal assistant and blogger living and working in the great city of Philadelphia. She frequently works with David Offen, Esq., a busy Philadelphia bankruptcy lawyer.