Chapter 7 and Chapter 13--"Cramdown" on Personal Property Collateral

 Posted on October 09, 2015 in Secured Debts

After covering Chapter 7 last time, now how does Chapter 13 help you keep (or surrender) collateral on a debt?

Last time we explained the crucial difference between secured and unsecured debts, and focused particularly on “purchase money” secured debts. That led to laying out the advantages Chapter 7 “straight bankruptcy” gives you when dealing with something you bought that is now collateral on the debt you owe.

Today we show the often even greater advantages that come under Chapter 13 “adjustment of debts” with this kind of collateral.

Creditor Leverage under Chapter 7

We showed last time how under Chapter 7 a secured creditor can require you to pay the debt if you want to keep the collateral. Even though you can “discharge” (legally write off) the debt, the creditor retains the right to repossess the collateral after your bankruptcy is over.

You can always just surrender the collateral—let’s say it’s a couch—and you would usually not owe anything on the debt once the Chapter 7 case was completed. But if you really want to keep the couch you may well have to pay much more than it’s worth, assuming you owe more than that.

The creditor uses as leverage against you its ability to repossess the couch. Your home or apartment may feel bare without the couch. You probably don’t have the cash to go out and buy another one, and your credit is likely not good enough at the moment to finance its purchase. So your creditor takes advantage of these circumstances by making you pay more, up to the full balance that you owe, no matter how little the couch is now worth.

Chapter 13 “Cramdown”

As long as you made your purchase at least a year ago, under Chapter 13 you can defeat this creditor leverage. You are allowed in effect to rewrite the terms of the debt based on the value of the collateral.

The debt is divided into two parts, one part being the value of the collateral, and the other part being the rest of the debt amount. The first part is treated as secured, and the other part as unsecured.

Using the example again of the couch, let’s say you paid $900 a year and a half ago for it but with a high interest rate and some missed payments you still owe $750. The couch was overpriced and depreciated quickly—you can’t sell a used couch for much—so it’s now only worth $300.

In a Chapter 7 case you may be stuck with the original payment terms, including the full balance of $750, the high interest rate, and the risk that down the line you wouldn’t be able to make the payments and the couch would still be repossessed, and you could still owe on the debt.

In contrast, through “cramdown” your Chapter 13 payment plan would have you pay $300 over the course of as much as 3 to 5 years, likely at a reduced rate of interest and usually a much lower monthly payment.

What Happens to the Unsecured Part of the Debt

The unsecured portion—the remaining $450 owed—would be lumped in with all your other “general unsecured” debts. This pool of debts is only paid as much as you can afford to pay during the length of your case after paying your secured debts, “priority” unsecured debts (such as recent income taxes and child/spousal support arrearage), and “administrative” expenses like your attorney fees and trustee fees. Often these “general unsecured” debts are paid only a few pennies on the dollar, or even nothing.

In many circumstances, even if you are paying some portion of the “general unsecured” debt, including this $450 unsecured debt on the couch, that doesn’t add a penny to what you have to pay in your Chapter 13 payment plan. That’s because usually you only have a certain amount of money that you can afford to pay to the entire pool of “general unsecured” debts after all your more important debts. So adding the $450 to that pool simply means that all the other “general unsecured” debts just get $450 less. You don’t pay any more.

Besides Paying Less, It’s Safer

In a Chapter 7 case you’re at the mercy of the creditor if you miss a payment on a debt after you’ve “reaffirmed” the debt—agreed to remain liable. The creditor would be able to repossess the couch, sell it, and come after you for any remaining debt after applying the sale proceeds to the debt balance.

There’s no protection against such creditor actions because your Chapter 7 case has been completed and closed, and the “automatic stay,” the protection against creditors’ collection actions, is no longer in effect. That’s not a problem with most or all of your other debts that were discharged, because those creditors can never pursue those debts again.

But with a reaffirmed debt you continue to owe it, and so if your circumstances change and you can’t make the payments you have no recourse unless the creditor is voluntarily willing to be flexible.

Under Chapter 13 the “automatic stay” continues in effect throughout the 3-to-5-year payment plan. If your circumstances change you and your attorney can usually make adjustments to that payment plan, all while being protected from the creditor. You would usually still be able to keep the collateral—the couch.

Or you may even decide at that point to surrender the couch, such as if you are now moving and don’t need it any more. The remaining debt would all be a “general unsecured” one, which, as explained above, would often not add anything to the amount you have to pay to complete your case.

Or finally, it may even make sense many months or even years into your Chapter 13 case to convert it into a Chapter 7 one. That would give you the option of surrendering the couch and owing nothing. Or at that point you could still keep it and pay the remaining debt or a negotiated lower amount. The couch may have even depreciated to being worth almost nothing, and you may be able to keep it without paying anything more.