Chapter 13 Bankruptcy Should Not (Sometimes) Be Used to Save Your House

May 18th, 2012

Although Chapter 13 is often the go-to prescription for hanging onto a home in financial distress, like most strong medicine it comes with side-effects. The simpler Chapter 7 “straight bankruptcy” may be the better solution for both short-term relief and long-term financial health.

Chapter 13, the three-to-five year version of consumer bankruptcy, arms you with a remarkable set of tools for dealing with your mortgage lender and with other creditors related to your home. I’ll talk about them in upcoming blogs.

But you should absolutely not enter into a Chapter 13 case without understanding it thoroughly and considering it very practically. The fact is that a large percentage of them do not make it all the way to completion, often wasting the debtors’ money and delaying for years their final relief from creditors. Chapter 13 is awesome medicine, but only for the right patients in the right circumstances.

So in what circumstances should you very seriously consider Chapter 7 instead of Chapter 13?

1. If you are behind on your mortgage payments, but could realistically catch up on that arrearage within about a year—after writing off the rest of your debts in Chapter 7, and being very disciplined during that one year:  Depending on your lender, your payment history, and similar factors, most mortgage lenders will allow you to enter into a “forbearance agreement” after you file a Chapter 7 case. That agreement allows you to stay in your home and to catch up on your mortgage arrearage by paying a certain amount extra per month. Given the cost savings of a Chapter 7 over a 13, and the benefit of getting to your fresh start in a year instead of three to five years, you should very seriously consider with your attorney whether that one year of extra effort would 1) be doable, and 2) be worth the effort and risk.

2. If your chances of keeping your house through a Chapter 13 case are unrealistic: As powerful as Chapter 13 is, it certainly has its limitations. Think long and hard about whether you will be able to consistently meet the terms of your proposed payment plan. Consider your deeper motivations and fears, and you may find better ways of meeting your and your family’s true needs. With the helpf of your attorney try to ground yourself with brutal honesty about what is realistic in the short term and also two or three years out. Although “desperate times call for desperate measures,” a desperate mind doesn’t tend to make wise choices. Chapter 13 should almost never be a “Hail Mary pass,” a last-ditch long-shot. Be very clear about the consequences of that long-shot not panning out, and you may well realize it’s not worth it.

So, aim towards a Chapter 7 instead of a Chapter 13 case if you really don’t need the extra length of time and other benefits that Chapter 13 provides. And the same thing if you are trying to hang onto a house that you very likely can’t hang on to even with all the help that Chapter 13 provides.

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Stronger Medicine for Vehicle Loan through Chapter 13 Bankruptcy

May 16th, 2012

If you are behind on your car or truck loan and a Chapter 7 case will not help you enough, file a Chapter 13 case instead so that you can keep that vehicle.

I laid out your options with vehicle loans under Chapter 7 bankruptcy in my last blog:

1. Surrender the vehicle and discharge (write off) any “deficiency balance”–the often large amount that outside of bankruptcy you would still owe after the creditor sells off your vehicle for less than the loan balance. The vehicle’s gone but so is all your debt.

2. Keep the vehicle and maintain the regular payments if you’re current. Or if you are behind, pay the full amount of back payments so that you are current within a month or two of filing the bankruptcy case. In both of these situations, you will almost certainly be required to sign a “reaffirmation agreement” renewing your full liability on the vehicle loan.

But what if you absolutely must keep your vehicle, and simply won’t be able to scrape up the money to catch up within a month or two after filing?  Some creditors may be somewhat more flexible—giving more time or even putting missed payments “at the end of the loan.” But these situations are relatively rare, and may not help you enough. Then it’s time to consider the Chapter 13 option with your attorney.

Keep the Vehicle through a Cram-Down

If you meet one straightforward condition, Chapter 13 gives you some tough medicine indeed, way beyond just buying you more time to pay the missed payments. Through the so-called cram-down, you get to re-write the loan—disregarding any missed payments. The balance on the loan is reduced to—crammed down to–the fair market value of the vehicle (assuming that’s less than the loan balance). Sometimes the interest rate can be reduced and often the loan term can be extended. The combined effect of all this is usually to reduce the monthly payment amount, often significantly. The amount of total savings depends on the details of your case, but most of the time you get the vehicle free and clear at the end of the Chapter 13 case after paying significantly less than you would have otherwise.

So what’s the condition you have to meet to be able to do this cram-down?  The vehicle loan must have been entered into more than 910 days (about two and a half years) before filing your Chapter 13 case. If your vehicle loan is not at least that old, no cram down.

Keep the Vehicle without a Cram-Down

You may not qualify for a cram-down because your loan is not old enough, or a cram-down could simply not do any good because your vehicle is worth more than the loan balance. But Chapter 13 can still be helpful, by not being obligated to catch up quickly on the back payments. And in the right circumstances, your monthly vehicle loan payments can be reduced, giving you more money for living expenses or to pay other important creditors.

Surrender the Vehicle

To be clear, although Chapter 13 gives you some big advantages if you are keeping your vehicle, if you don’t need that vehicle you can surrender it just as you can in a Chapter 7 case.

The difference is that instead of the “deficiency balance” being discharged without the creditor receiving anything as in the vast majority of Chapter 7 cases, under Chapter 13 that “deficiency balance” is added to the rest of the pool of general unsecured creditors.

What’s the effect of that? In most cases it doesn’t cost you anything, nothing more than what you would have paid to complete your Chapter 13 case without that “deficiency balance” included. Why? Because in most Chapter 13 plans, you are required to pay a certain amount based on your budget, or a certain minimum amount to the unsecured creditors based on assets you are protecting. So in those cases having an extra chunk of unsecured debt merely shifts how the creditors divide up among themselves the same amount of your money.

But there are some uncommon situations in which adding that “deficiency balance” to your unsecured debts would increase the amount you would have to pay into your Chapter 13 plan. Discuss whether any of those apply to you before deciding whether surrendering your vehicle in a Chapter 13 is in your best interest.

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Options with Your Vehicle Loan under Chapter 7

May 14th, 2012

Your car or truck loan may be the most important debt you have. Chapter 7 bankruptcy puts you in the driver seat for dealing with this debt.

As I said in the last blog, when you think about secured debts—those tied to collateral like a vehicle—it helps to look at these kinds of debts as two deals in one. You made a commitment to repay some money lent to you, and then agreed to back up that commitment by giving the creditor certain rights to your collateral.

The first deal—to repay the money—can almost always be discharged (legally erased) in bankruptcy. But the second deal—the rights you gave up in the collateral, here a lien on the vehicle title—is not affected by your bankruptcy. So, you can wipe out the debt, but the creditor remains on the title and can get your vehicle. Your options in Chapter 7, and the creditor’s, are tied to these two realities.

Keep or Surrender?

As long as you file your Chapter 7 case before your vehicle gets repossessed, the ball starts in your court about whether to keep or surrender it.

Surrender the Vehicle

In most situations, if you want to surrender the vehicle, then doing so in a Chapter 7 bankruptcy is the place to do it. That’s because in the vast majority of vehicle loans, you would still owe part of the debt after the surrender—the so-called “deficiency balance”—often a shockingly large amount. That’s because you usually owe more than the vehicle is worth, but also because the contract allows the creditor to charge you all of its costs of repossession and resale. Surrendering your vehicle during your Chapter 7 case allows you to discharge the entire debt and not be on the hook for any of those costs.

To be thorough, there is a theoretical possibility that the vehicle loan creditor could challenge your discharge of the “deficiency balance,” based on fraud or misrepresentation when you entered into the loan. These are rare, and especially so with vehicle loans.

Keep It

Whether or not you are current on the loan payments does not matter if you are surrendering the vehicle. But if you want to keep it, whether you are current, and if not how far behind you are, can make all the difference.

Keep the Vehicle When Current

As you can guess, it’s simplest if you are current. Then you would just keep making the payments on time, and would usually sign a “reaffirmation agreement” to exclude the vehicle loan from the discharge of debts at the end of your Chapter 7 case.

Most conventional vehicle loan creditors insist on you signing a reaffirmation agreement, at the full balance of the loan—it’s a take-it-or-leave-it proposition. If you want to keep the car or truck, you need to “reaffirm” the original debt, even if by this time the debt is larger than the value of the vehicle. This can be dangerous because if you fail to keep up the payments later, you could still end up with a repossession and a hefty remaining balance owed—AFTER having passed up on the opportunity to discharge this debt earlier in your bankruptcy case. So be sure to understand this clearly before reaffirming, especially if the balance is already more than the vehicle is worth.

Some creditors—more likely smaller, local lenders—may be willing to allow you to reaffirm for less than the full balance, so that the creditor avoids taking an even bigger loss if you surrender the vehicle. Talk to your attorney whether this is a possibility in your situation.

Keep the Vehicle When Not Current

If you are not current on the vehicle loan at the time your Chapter 7 case is filed, most of the time you will have to get current quickly to be able to keep the vehicle—usually within a month or two. That’s in part because for a “reaffirmation agreement” to be enforceable, it must be filed at the bankruptcy court before the discharge order is entered. Since that happens usually about three months after the case is filed, the creditor needs to decide quickly whether you will be able to catch up on the payments and reaffirm the debt.

Again, certain vehicle creditors may be more flexible, perhaps letting you skip some earlier missed payments, or giving you more time to cure the arrearage. Your attorney will know whether these may apply to your creditor.

Stronger Medicine through Chapter 13

But what if you are behind on your payments more than you can catch up within a month or two after filing? If you have decided that you really need to keep the car or truck, discuss the Chapter 13 bankruptcy option with your attorney. Depending on various factors, you may not only have more time to pay the arrearage, you may also reduce your monthly payments, the interest rate, and the total amount to be paid on the debt. The next blog will get into this Chapter 13 option.

 

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