How Does a Cramdown Work in Chapter 13 Bankruptcy?

Find out how to reduce the principle of a secured debt in Chapter 13 bankruptcy.

by: , Attorney

If you are upside down (owe more than the property is worth) on your car, certain real estate, or other personal property (any property other than real estate), then a Chapter 13 bankruptcy may allow you to reduce the principal balance and interest rate of these debts.  This is called a “cramdown.”

What Loans Qualify for a Cramdown? 

You can cram down your car loan, your other personal property loans (such as furniture or household goods), and your mortgage on any property that is not your principal residence (such as commercial or investment properties).  However, each type of loan has certain restrictions and limitations which we will discuss below.

How Does It Work?

Since cars begin to depreciate quickly the moment you drive them off the lot, this is the most common example of using a cramdown.  However, the same process applies to other types of loans eligible for a cramdown as well.

Let’s say you bought a car in 2007 for $20,000 and took out a loan for $20,000. Now in 2011, you still owe $15,000 on the loan but the car is worth $10,000 so only $10,000 of the loan is secured (this is the amount the creditor would get if it repossessed and sold the car).  A cramdown can reduce your loan balance down to the secured portion ($10,000) because this is the “replacement value” of the car.

Through your Chapter 13 repayment plan, you will only pay $10,000 (instead of the $15,000 balance) to your car lender and own the car free and clear at the completion of the plan.  As an added benefit, you may be able to reduce your interest rate on the new reduced balance as well.  The interest rate will be set by the bankruptcy court and will depend on which district you live in, but will usually be lower than your note rate.  

(To learn more about cramming down car loans, see How a Bankruptcy Cramdown Can Reduce Your Car Payments.)

What Happens to the Unsecured Portion of My Loan?

In the above example, the remaining $5,000 of your loan balance will be treated the same as your other unsecured debts such as credit cards and medical bills. Normally, unsecured creditors receive only a small portion of what they are owed in a Chapter 13 bankruptcy so it is likely that you will pay much less than $5,000, if anything at all. Any unpaid portion will get discharged (wiped out) along with your other unsecured debts upon completion of your bankruptcy plan.

Timing Restrictions

There are certain limitations to using a cramdown and they depend on the type of loan you are trying to cram down.

910-day Rule:

This rule only applies if you are trying to cram down a car loan.  It requires that you must have purchased the vehicle and taken out the loan at least 910 days (approximately 2 ½ years) prior to filing the bankruptcy. So you cannot use a cramdown on cars you recently bought. There is an exception to this rule if you bought the car for your business.

One-year Rule:

This rule applies to all personal property loans other than car loans (most common examples are furniture or household goods bought with in-store financing). Similarly, it requires that you must have purchased the goods at least 1 year prior to your bankruptcy.

Mortgage on Property Other Than Your Principal Residence:

While there are no specific timing restrictions on using a cramdown for this type of loan, most courts require that the reduced balance of any crammed down loans be paid off at the completion of your Chapter 13 repayment plan (which lasts 3 to 5 years).  Since most people are unable to pay off a mortgage in this short amount of time, they are unable to take advantage of a cramdown in this situation as a practical matter.

(To learn more about cramdowns on real estate loans, see Reduce Investment or Rental Property Debt With a Bankruptcy Cramdown.)

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