When an individual falls behind on secured debt payments, there isn’t a lot of good news that we can give. Option one is to walk away from the collateral, thereby changing the nature of the debt from secured to unsecured. Typically, unsecured creditors receive little or nothing in a bankruptcy case. The downside, of course, is that the individual no longer has the benefit of the house or car. Option two, for real estate, is to cure the arrears over a five year period of time while maintaining the on-going contractually due payments. This second option is particularly challenging for the simple fact that filing a bankruptcy case (at least as to the real estate) actually increases how much money a debtor is having to pay each month to keep his house. If any savings are going to be generated by filing a chapter 13 bankruptcy case, they’ll have to come from somewhere else. The good news is, the savings often do. But from where?
First, in most cases, general unsecured creditors receive so little in bankruptcy cases that, if the debtor has been attempting to pay these creditors, the relief in no longer being required to pay these debts can free up enough extra money to devote to curing the mortgage arrears.
Secondly, vehicle loans, while clearly entitled to their preferred status in a bankruptcy case as secured debts, can nonetheless be altered some: the term of the loan can be extended for the duration of the chapter 13 bankruptcy case (60 months) and the interest rate can be reduced to 5.25%. If the vehicle loan was obtained more than 910 days prior to the bankruptcy filing, the loan balance can be actually reduced to the value of the vehicle.
Taking advantage of these two – possible three – benefits in a chapter 13 case seems obvious, but it’s not. Because chapter 13 cases are difficult to complete successfully when they involve the curing of large mortgage arrears, debtors are sometimes forced to covert their cases from chapter 13 to chapter 7 and surrender their homes. That doesn’t mean, though, that they want to give up their car. The problem lies in the fact that, having stretched the loan term, reduced the interest, and (possibly) crammed the loan principle down to the value of the car, when the case converts from chapter 13 to 7 all these benefits are lost. And not only are they lost, but the vehicle financing company will be reminding the debtor that under the terms of the original contract (which will govern in a chapter 7) they are in default.
Prudently planning a chapter 13 case is always complicated by the uncertainties of life, and five years is a long time to be sure of anything, let alone something as ultimately trivial as being able to afford a piece of real estate (even one you call home). However, if someone feels especially unsure of the likelihood of successfully completing a chapter 13 case, the benefits of altering those terms of a vehicle loan in that case may be short lived. Sometimes, the most prudent action is to keep one financial affliction (a mortgage delinquency) from infecting the health of a vehicle loan.