Example of Reaffirming vs. Cramming Down Furniture Loan

An example comparing the reaffirmation of a debt secured by furniture in a Chapter 7 case and cramming down that debt in a Chapter 13 case. 

 

Last time we showed how cramdown on a vehicle loan can reduce the payments and the total amount you pay. The amount you save monthly and in total may be enough to justify filing a Chapter 13 case. The alternative is usually paying the full monthly payments and the full contract balance through Chapter 7 reaffirmation.

Cramdown on Debt Secured by Non-Vehicle Personal Property

The concept is the same with secured debts on personal property other than your vehicle. Chapter 13 allows you to re-write the debt based on the value of the collateral, such as furniture you bought. That collateral value amount becomes the secured part of the debt. You pay that part in full, with interest but often at a lower interest rate. The monthly payment is almost always less than the contract amount. That’s because it’s based on the value of the collateral, which is less than the full loan balance.

Also, the total paid on the debt is usually less because the remaining unsecured part of the loan almost always is never paid in full, and is often paid quite little.

The following example helps make sense of this, including how furniture/personal property cramdown is different from vehicle loan cramdown.

The Background Facts

Let’s say Michael and Jessica moved 2 years ago to their present home in a new state, pursuing job opportunities. They bought a substantial amount of furniture and appliances for the home and their two middle school-aged children. That seemed to make more sense at the time because their kids had just outgrown their beds and other furniture. They bought and financed $5,500 worth of stuff.

After 6 months grace period, they began making the $180 monthly payments. At an interest rate of 24% per year, these payments were to last 48 months.

Then a year ago Michael was hit with a serious illness that lasted 6 months. Although he’d thought his work-based insurance was decent, he still ended up with $18,000 in medical bills. He had some disability insurance through work, but it provided only a portion of his normal income. So Michael and Jessica did not have the money to make the furniture/appliance loan payments, or pay the medical bills. Today they still owe $5,000 on the furniture/appliance loan. They also fell behind on their other substantial unsecured debts—personal loans and credit cards.  They are now being sued by a collection company on one of the larger medical bills.

The Chapter 7 Reaffirmation Option

They go to see a bankruptcy lawyer about their options. The lawyer informs them that a Chapter 7 bankruptcy filing would discharge—legally write off—all of the medical debts and indeed all of their debts. They would no longer owe anything on them.

An exception is the furniture/appliance loan. They COULD surrender all of the furniture and appliances and owe nothing. But that would largely empty out their home. Jessica and Emily are hesitant to do that, mostly because it would be hard on their kids.

Their other option is to reaffirm the debt. This means that they would agree to continue being liable on the debt. They would exclude that one debt from the discharge of debts that the Chapter 7 case would provide them.

Two Possible Reaffirmation Options

As we saw in the last blog, most vehicle lenders require you to reaffirm the debt without any change in its terms. Take it or leave it. If you want to keep the vehicle you must sign back on for the full debt, all of the contract terms. That’s true even if the vehicle is worth less than what you owe on it.

Creditors secured by non-vehicle personal property tend to be more flexible. Furniture and appliances lose their value even faster than vehicle. There is a well-established system of auto auctions for getting cash for repossessed vehicles. But furniture and appliances, and especially electronics, turn almost valueless, and are a pain to cash in. Creditors tend to be happy to get paid something by their customer rather than having to go through the hassle of repossessing and selling the used furniture/appliances for very little money.

So Jessica and Michael may not be stuck with a full reaffirmation. Their lawyer may well have a history of dealing with their furniture/appliance creditor. The lawyer may well be able to negotiate a reaffirmation at reduced monthly payments, on a reduced total debt. For example, both sides could agree the furniture/appliances now are worth only $2,500. Michael and Jessica could agree to pay that amount on monthly payments of $97, for 30 payments, at 12% interest. That would be close to half as much per month ($97 vs. $180), over a shorter period of time (30 months vs. 41 more months on the contract). The savings—both monthly and overall—would be substantial.

Cramdown In Chapter 13

But what if the creditor insisted on a full reaffirmation—$180 per month on the $5,000 contract balance? It’s possible, but again most creditors under these facts would be more flexible.

But if not, Michael and Jessica have the Chapter 13 cramdown option.

There is one condition. The debt has to be at least 1 year old at the time of their Chapter 13 case filing. (This is in contrast to 2 and a half years with vehicle.) Here the debt is 2 years old so this condition is met.

In their Chapter 13 payment plan their lawyer would specify terms very similar to the reaffirmation just mentioned above. The $5,000 debt would be divided into the $2,500 secured portion and the remaining $2,500 unsecured portion. The plan would designate $97 per month to be paid to this creditor over about 30 months at 6% interest. That would pay off the secured portion.

The remaining $2,500 unsecured portion would be put into the pool of medical bills and all the other debts. This pool would be paid only if and to the extent there was money left over. Let’s assume that 5% of this pool got paid in Michael and Jessica’s Chapter 13 case.

So, through cramdown this furniture creditor would be paid the $2,500 secured portion, at reduced interest. It would also receive 5% of the remaining $2,500, or another $125. This is a total of $2,625 (plus some interest). Jessica and Michael and their kids would be able to keep the furniture. At the end of the payment plan the rest of the furniture/appliance debt, and all the rest of their debts, would be forever discharged.

Conclusion

These two options—reaffirmation or cramdown—give a lot of control to Michael and Jessica. They can keep or let go of the collateral. If they keep it and the creditor is sufficiently flexible, a reaffirmation with reduced terms can work well. If the creditor insists on not changing the terms, Jessica and Michael can chose to go along. It would be a way to start rebuilding their credit record faster. But if they want to pay less they can use a Chapter 13 cramdown instead.