One of the advantages of filing for bankruptcy under Chapter 13 is the ability to “cram down” a debt secured by property. This involves reducing the balance owed on the debt to the value of the asset attached to it. Cramdowns often are associated with car loans, but they can apply to investment property mortgages and other types of property, even including furniture and household items. One key exception of which to be aware is that you cannot cram down the mortgage for your principal residence unless it meets certain requirements. (Read more here to find out whether your mortgage may meet these requirements.)
What makes a debt secured and eligible for a cramdown? This is a debt in which the lender receives a security interest in a specific asset owned by the debtor and has the right to take back the asset if the debtor does not keep up with loan payments.
Reasons to Cram Down a Loan
Using a cramdown can reduce the monthly payment that you make on a loan by extending payments over a longer period. The payment period may last throughout the duration of a Chapter 13 bankruptcy, which will be three to five years. The bankruptcy court also may intervene to lower the interest rate on the loan. Once you pay off the loan, you will own the asset free and clear.
Assume that you still have $20,000 to pay in the balance of your loan, but your car is only worth $12,000. The secured part of the loan can be reduced to $12,000, and the remaining $8,000 would be reclassified as non-priority unsecured debt. These types of debts may never be paid off in a Chapter 13 bankruptcy, or they may be paid off only in part. Either way, you will not need to worry about the unsecured portion of the debt after your bankruptcy is complete, assuming that you have kept up with payments under the repayment plan and paid off the other $12,000.
Limitations on Cramdowns
Federal law prevents debtors from using cramdowns in some situations involving recent purchases. The restrictions depend on whether the potential cramdown applies to a car, personal property, or investment property. For a car loan, you must have purchased the car at least 910 days before you filed for bankruptcy under Chapter 13. Otherwise, a debtor might be tempted to buy an expensive new car shortly before filing for bankruptcy and then immediately cram down the loan. This would create unfair results for lenders.
Parallel to the 910-day requirement, a one-year rule applies to all other types of personal property, such as household appliances. Federal law requires that people trying to cram down a loan on personal property other than a car must have purchased the item attached to the loan at least one year before filing under Chapter 13.
Special Issues Involving Investment Property Mortgages
Finally, you should be aware that cramming down an investment property mortgage may pose certain problems. The idea behind cramming down a loan is that it will be paid off within the length of your Chapter 13 repayment plan, which is three to five years. In many situations, a debtor will not be able to pay off even the crammed down version of a mortgage on investment property within three to five years. This usually results in a balloon payment at the end of the plan, which someone facing financial difficulties may not be able to handle. As a result, many debtors opt against cramming down a mortgage on investment property.