If your vehicle is worth less than you owe, or you are paying excessive interest, cramming down a car loan in a Chapter 13 bankruptcy can reduce your balance, cut your interest rate, and slash your payment. A “cramdown” of an auto loan is a major benefit available in Chapter 13 that is not available in Chapter 7 bankruptcy.
Bad car loans can be devastating financially. As a bankruptcy firm in Wisconsin, we have seen clients with auto loans nearly two times the value of their vehicles and at higher than 20% interest. However, it is not only debtors with egregiously bad loans who benefit from Chapter 13 cramdowns. Unexpected depreciation of a vehicle’s value and a modestly high interest rate will quickly place almost anyone underwater on a car loan.
Cramming Down the Balance on an Auto Loan
Cramming down your car loan balance in Chapter 13 reduces the balance to the vehicle’s fair market value. This new lower amount will be paid over 36 to 60 months through a Chapter 13 plan. Any remaining balance becomes an unsecured debt like your credit cards, medical bills, etc. Because most Chapter 13 debtors pay only a small portion of their unsecured debt (often pennies on the dollar), cramming down the balance can save you thousands of dollars.
Example: Jill has a car worth $12,500, but the balance on her auto loan is $18,500. Her payment is $511 per month at 6% interest. In Chapter 13, Jill can cram down the balance to $12,500. Therefore, her payments would be based upon this new lower balance. The remaining $6000 becomes an unsecured debt, which will most likely be paid back at pennies on the dollar. Jill’s payments will be reduced to $241 per month when paid through a 60-month Chapter 13 plan.
Cramming Down the Interest Rate on an Auto Loan
The Bankruptcy Code also allows debtors to cram down the interest rate on a vehicle loan. Here in the Eastern District of Wisconsin a rate of one or two points over prime is standard. The current prime rate (as of the date of this post) is 3.25%. Therefore, the court will allow a cram down of the interest rate in the range of 4.25% to 5.25%. If you are paying a high interest rate, even a drop of a few points can make a significant difference.
Example: Don is paying 10% interest on his car loan and has a balance of $7500. His current car payment is $369 per month, and he has 24 months left on the loan. If Don crams down his car loan to one point above prime, he would pay 4.5% interest on his loan, saving him 5.5 percentage points on his interest rate. In a 60-month Chapter 13 plan, Don’s payment would be reduced to $139.
Quick Note: A debtor filing under Chapter 13 can cram down the balance and interest rate on any secured loan, with the exception of mortgage loans on the debtor’s primary residence. Thus, the same principles apply to loans for cars, trucks, boats, refrigerators, and any other secured property. In addition, the Bankruptcy Code allows debtors to cram down and strip the lien on a second mortgage that is not secured by equity in the home. Mortgages on rental property are also subject to cramdown.
The 910-Day Rule
To be eligible to cram down the balance on an auto loan, you must have purchased the vehicle at least 910 days (2.5 years) prior to the date that you filed your Chapter 13 bankruptcy. The 910-day rule does NOT apply to cramming down interest rates – you will be able to reduce the interest rate to prime plus one point regardless of when the vehicle was purchased.
Stretching Out Payments on an Auto Loan
Another advantage of Chapter 13 bankruptcy is that you can stretch out your payments over the course of your 36 to 60 month plan, regardless of whether you are eligible for a cramdown. For example, if you have 36 months left on your auto loan, by placing it in a 60-month Chapter 13 plan, you can spread your loan out over 24 more months and significantly reduce the payment.
Quick Note: Chapter 13 can also help you catch up on your payments, if you are behind on your car loan. However, a cramdown is available even if you are current with your payments.
The Power of Three
When you combine a cramdown of the balance, a cramdown of the interest rate, and the ability to stretch your payments out over the life of your Chapter 13 plan, the savings can be substantial.
Example: Bob’s car is worth $11,000, but he has a loan balance of $15,000 at an interest rate of 9%. Bob’s payments are $477, and he has 36 months left on the loan. Bob files for Chapter 13 bankruptcy and proposes a 60-month payment plan. If Bob crams down the balance on the loan to the fair market value of $11,000 and crams down the interest rate to 4.5%, his new car payment will be $205.
Thus, a Chapter 13 cramdown can not only save your car, but also save you thousands of dollars.
At the Bankruptcy Law Center LLP, we cover all aspects of bankruptcy. To learn how cramdowns and filing a Chapter 13 bankruptcy can help you, call an experienced lawyer such as attorney James Stanek at the Bankruptcy Law Center LLP at (414) 257-1900.