What happens if a person owes more on their car than it is worth? In Chapter 7, the debtor should file a motion to redeem the car at its fair market value. But what if the debtor is in Chapter 13 instead? Are there any remedies available?
The answer is yes; it’s called a cramdown. Section 1325(a)(5)(B) allows the court to reduce the balance of the loan to the fair market value of the collateral (the “cramdown.") Section 506 of the code allows the debtor to file a motion to value secured collateral. If successful, then the debtor will only have to repay the fair market value of the vehicle (the secured portion of the loan.) The unsecured portion (the amount over the fair market value) will be treated like the other unsecured debts in the Chapter 13 plan and the debtor will usually pay less than 100% of those debts.
So what is to prevent a debtor from going out and buying a very expensive car the day before filing bankruptcy and then cramming down the day after it loses 1/3 of its value? The loan must be at least 2.5 years old in order to qualify.
The Cramdown is part of the Chapter 13 Plan filed with the court. Then the attorney will file a Motion for Valuation of Collateral and Notice of Motion, under section 506 of the Bankruptcy Code. The court will schedule a hearing, and if the creditor disputes the fair market value of the vehicle, the parties will need to go to court and have experts testify as to its value.
Some lawyers recommend objecting to the lender’s claim, as well. http://lexingtonlawyer.wordpress.com/2011/01/29/objecting-to-a-claim-in-a-chapter-13-for-a-506-cram-down/
The interest rate can also be reduced in a Chapter 13 cramdown. In Till v. SCS Credit Corp., 541 U.S. 465 (2004), the Supreme Court ruled that the new interest rate will be calculated by taking the prime interest rate and adjusting it upward based on the additional risk involved in lending to a bankrupt debtor. The Wall Street Journal prime interest rate is 3.25% as of the writing of this article on April 13, 2012. It can be found at http://www.bankrate.com/rates/interest-rates/prime-rate.aspx?ec_id=m1027769&ef_id=FW1Pfb9IYXAAAIHV:20120413150755:s
Chapter 13 debtors can also cram down on real estate mortgages, on any property except their own residences.