Sometimes you can find yourself “underwater” on a secured loan, owing more on your balance than the property is worth. For some kinds of property, under the U.S. Bankruptcy Code, Chapter 13 bankruptcy allows you to address this problem by reducing the balance owed to the value of the property. This mechanism is called a “cramdown.”
In combination with the debt-repayment plan that is integral to a Chapter 13 case, a cramdown can help you keep property, such as your car or home, while reducing your total debt.
Stone Rose Law represents Arizona residents who need debt relief, including bankruptcy. In this article, we describe how a Chapter 13 cramdown works and how you can use it to your advantage if you need help with overwhelming debt.
To speak with one of our experienced Arizona bankruptcy attorneys, call our law office at (480) 739-2448 or use our online contact form to schedule a free consultation.
When Can I Use a Bankruptcy Cramdown?
There are three considerations that go into whether you can use the cramdown in bankruptcy:
- Your amount owing on the property must exceed the property’s value.
- You can only use a cramdown in Chapter 13 bankruptcy.
- Cramdown is only for secured debts, not unsecured ones.
To use a cramdown, you must first qualify for Chapter 13 bankruptcy, which requires having regular income and total debt below certain limits.
Under 11 U.S.C. § 506, the Bankruptcy Code allows a court to split a secured debt into two parts: the secured portion, which equals the current market value of the collateral, and the unsecured portion, which covers everything you owe above that amount.
The most common examples of certain secured debts subject to cramdown are investment real estate mortgages (generally not your primary residence mortgage), car loans, loans on household goods and furniture, and other personal property such as appliances and electronics. Debtors can also cramdown loans on vehicles like motorcycles, RVs, boats, and trailers.
Often, using a cramdown can result in a reduced interest rate, lower monthly payments, and more time to pay off the loan on your secured property.
The bankruptcy court sets the interest rate on your crammed-down loan through your Chapter 13 plan, typically using a formula based on the prime rate plus a risk adjustment, which is usually lower than your original contract rate.
By reducing what you owe to secured creditors, a cramdown can free up money in your budget to cover legal fees and other costs associated with filing for bankruptcy.
Here is an example of how the Chapter 13 cramdown works: Let’s say that you are financing a car. You still owe $10,000 on it, but its fair market value is $7,500. The cramdown will allow you to reduce your loan balance to $7,500. You make your loan payments on this new principal balance through the case. When you complete your case, you will own your car free and clear.
You must still pay the secured portion of the loan with interest sufficient to provide present value. The unsecured portion of the loan above the collateral’s worth—in our example, $2,500—becomes unsecured debt. You will pay this unsecured debt on a pro-rata basis, and any leftover amount can be discharged upon completion.
Are There Any Restrictions on When I Can Use a Cramdown?
To prevent debtors from using the bankruptcy cramdown to take advantage of secured creditors, federal law imposes time limits on this relief for recent purchases of personal property. There are two restrictions: the 910-day rule for car loans and a one-year restriction for other secured debts.
The 910-Day Rule for Car Loans
A vehicle cramdown is barred only if the lender holds a purchase-money security interest on the vehicle, the car was purchased as personal property for your own use, and the debt was incurred within 910 days (about two and a half years) before filing.
If all three of these conditions apply to your car loan, then you cannot cramdown that loan and must pay the full balance you owe. However, if any one of these conditions is missing—for example, you purchased the car for business use, or the loan is older than 910 days—a cramdown may be available.
The One-Year Rule for Other Secured Property Loans
The one-year rule similarly prevents cramdown of non-vehicle personal property purchased within one year before filing for bankruptcy, but it does not involve the personal-use analysis applicable to the car loan restriction.
Cramdowns and Investment Property Mortgages
Investment property mortgages are not subject to this timing restriction. But a challenge for many debtors who own investment real estate is that the statutory maximum plan length of three to five years under 11 U.S.C. § 1322(d) requires the mortgage to be paid off within that period.
If the debtor cannot pay the full secured amount within this period, the mortgage holder will still have a lien on the investment property and can enforce it or resume foreclosure after the case closes. Most courts enforce this strictly. Remember that, unlike an investment property mortgage, your primary residence mortgage cannot be crammed down in Chapter 13.
Are There Any Risks in Using a Cramdown?
The cramdown itself is safe to use, but how it interacts with other factors is a consideration.
Valuation Disputes
The bankruptcy court must agree with your valuation of the collateral you are seeking to use a cramdown on. Sometimes the affected creditor may object to your valuation, claiming that the property is worth more. You will need to provide credible evidence to support your valuation, like appraisals or other market data.
Creditor or Trustee Objections
The bankruptcy trustee and creditors will closely scrutinize your filing. Creditors in particular will be on the lookout for problems such as failing to meet the “best interest of creditors” test, a lack of feasibility, or even bad faith.
The trustee may object to the cramdown if your non-exempt equity is not enough to pay unsecured creditors, or if your disposable income is not fully committed, or if the collateral is unnecessary or excessive for your circumstances.
Failure to Comply With Your Debt Repayment Plan
A cramdown is necessarily connected with your ability to keep up with your Chapter 13 repayment plan’s monthly payments. If, for any reason, you cannot complete your plan payment period, such as due to a loss of income, this may result in a dismissal of your bankruptcy.
If the court dismisses your case, then your automatic stay will expire, and any original, pre-cramdown rights of your lenders may be restored.
If you choose to convert your Chapter 13 to a Chapter 7 case, the Debt Repayment Plan is no longer in effect, and the Cram Down is void. Pre-cramdown rights of your lenders are restored. If you wish to keep the vehicle, you must make arrangements to resume payments on the original contract. The only other option if you convert to a Chapter 7 is to negotiate a reaffirmation or seek a redemption.
You May Still Pay More Than What the Collateral is Worth
Once your crammed-down loan is in place, there is no guarantee that the collateral will not continue to drop in worth. If this happens, you are still obligated to pay the court-approved secured amount, plus interest.
Cramdowns are Hard to Modify Once in Effect
Once the bankruptcy court confirms your cramdown, if you need to modify it for any reason, you will need court approval, which is not guaranteed and may be subject to objection by the affected lender.
Ultimately, a cramdown is riskier to pursue if your valuation of the property is uncertain, your income is unstable and could threaten your ability to complete your repayment plan, the asset in question is not essential, or you have significant non-exempt equity elsewhere in your bankruptcy estate.
Do You Have Questions About the Chapter 13 Cramdown?
A cramdown is a court-supervised refinancing mechanism that works in combination with your debt repayment plan. If it is right for you, it can enable you to keep your secured property and may save you thousands of dollars over the life of your loan.
But it is not without its risks, and if it does not work for you, it can increase your costs, lock you into an unworkable payment plan, or even lead to a case dismissal.
An experienced bankruptcy lawyer, like one of our attorneys at Stone Rose Law, can help you determine if a cramdown is something you can use as part of a Chapter 13 bankruptcy plan. If a cramdown is not possible in your particular circumstances, we can help you evaluate your other debt relief options, including bankruptcy and non-bankruptcy alternatives.
To learn more about your options and to get professional help with your debt elimination needs, call our law firm at (480) 739-2448 or reach us online.
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