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Upside Down on Car Loan – Chapter 13 Cram Down Provisions and Chapter 7 Redemption

Clients often find themselves in need of debt relief due to a car loan gone bad.

Modern society requires owning and maintaining a car, which sometimes becomes a devastating financial burden. Lenders are quick to finance vehicles knowing that borrowers prioritize auto transportation over most other financial obligations. Even borrowers with bad credit are included in auto financing packages with high interest rates to compensate aggressive lenders for the added risk.

Financial difficulty often arises from car financing. The happy car buyer gets his new vehicle off the lot almost 100% financed. As the saying goes, almost immediately thereafter, the value of the new vehicle depreciates by several thousand dollars before it hits the road.

Car transportation costs $4,000.00 to $6,000.00 annually, including car loan payments, liability and collision insurance, repairs and maintenance, and gasoline.

The chaos begins when an unexpected non-warranty car repair, or car accident, unexpectedly and substantially lowers the value of the vehicle well below the outstanding loan balance owed to the bank. Or, perhaps more harmlessly, we trade in for a new vehicle where eager car dealers and lenders agree to take your old vehicle in return, and toss the remaining outstanding balance on your old car loan (for a slightly higher payment). on the back end of their new car loan leaving the new car buyer considerably ‘upside down’ on the new vehicle purchase.

These situations leave the borrower in a position where a significant portion of income is devoted to covering an unsecured automobile debt obligation that does not serve to support the modest costs of the necessities of family life.

Under certain circumstances, relief from these devastating financial predicaments can be obtained through bankruptcy filing.


Under Chapter 13 of the United States Bankruptcy Code, Debtors can “reduce” the unsecured portion of their auto loans to the fair market value of the vehicle that secures the loan. This requires borrowers to pay only the secured portion of the auto loan, but the unsecured balance is treated as a general unsecured creditor that provides a substantial benefit to the Borrower, allowing them to pay only a small fraction of the unsecured portion of the loan. auto loan debt. what is owed

As an example, let’s say our debtor owns a car worth $10,000.00 and there is a car loan with a payment balance of $20,000.00. In this scenario, the loan is only partially guaranteed. The auto lender is insured only to the extent of the value of the vehicle or $10,000.00. The remaining balance of $10,000.00 on the loan is not guaranteed. In this situation, the Bankruptcy Code gives the Debtor the right to cut off the unsecured portion of the auto loan and treat that portion of the loan as unsecured. Therefore, if general unsecured creditors only received a 20% dividend, the auto lender would receive only $2,000.00 on their unsecured portion of the auto loan.

These situations become complicated between the Debtor and the Lender because disagreements often arise about the correct value of the vehicle. Your bankruptcy attorney will need to negotiate an appraisal agreement prior to confirmation of the debtor’s Chapter 13 plan.

The valuation is governed by the provisions of the United States bankruptcy code, specifically 11 US Code § 506 – Determination of secured status.

11 USC §506(a)(2) specifically states:

“If the debtor is an individual in a case under chapter 7 or 13, such value with respect to personal property securing a permitted claim shall be determined based on the replacement value of such property on the date the petition is filed. no deduction With respect to property acquired for personal, family, or household purposes, replacement value shall mean the price that a retailer would charge for such property considering the age and condition of the property at the time it is appraised. ” emphasis added

The Cram Down provision under the bankruptcy code also provides for a reduction in the interest rate on the auto loan. Borrowers often find themselves shelling out huge used car payments to cover the exorbitant interest rates auto lenders often charge risky borrowers.

An interesting exception was enacted under the 2005 amendments to the United States Bankruptcy Code that prohibit cram downs when the auto loan was originated within 910 days (2 1/2 years) of the Chapter 13 bankruptcy filing date. [see 11 U.S.C §1325(a)(9)]. Debtors should consider filing for Chapter 13 if they want to escape the burden of onerous auto loan debt. Bankruptcy rules require auto loans taken out within 2 1/2 years of filing for bankruptcy to be repaid as agreed.


Cram downs are not allowed under Chapter 7 bankruptcy (or ‘straight bankruptcy’). But, Chapter 7 debtors can ‘redeem’ personal property under 11 USC §722.

11 USC §722 states the following:

“An individual debtor may…redeem tangible personal property intended primarily for personal, family, or household use from a lien securing a dischargeable consumer debt, if such property is exempt under section 522 of this title or has been abandoned pursuant to section 554 of this title, by paying to the holder of such lien the amount of such holder’s allowable secured credit that is secured by such lien in full at the time of redemption.” emphasis added

However, redemption can be difficult under Chapter 7 because debtors must pay up front a lump sum of cash sufficient to pay off the secured portion of the auto loan measured by the fair market value of the vehicle at the time the Debtor seeks to redeem the vehicle. Chapter 7 does not allow for a loan restructuring, but sometimes the auto lender will accept payments over time, but usually within a short period of time.


If your vehicle is worth less than it owes, bankruptcy options may be advantageous in allowing you to retain your vehicle and move toward better financial health.

Chapter 13 can reduce or “crash” your loan balance and interest rates, lowering your car payment and making it affordable. Chapter 13 also allows you to restructure past due auto payments and spread them over the term of the Chapter 13 plan so you can catch up on past due payments within your personal financial means.

Chapter 7 bankruptcy is not suited to restructuring loan payments, but the redemption provisions of §722 allow debtors to purchase their vehicles out of bankruptcy for the fair market value of the vehicle, leaving the unsecured portion of debt discharged under Chapter 7 bankruptcy.

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