Chapter 13 gives you powerful ways to hold onto a vehicle, but it also lets you give up that vehicle without paying its debt.
Our last several blog posts have been about situations in which secured debts can be turned into unsecured debts. They’ve all been about how this can happen in a Chapter 7 “straight bankruptcy.” But how about in a Chapter 13 “adjustment of debts” case?
Today we’ll start a series of blog post about secured debts turning into unsecured ones under Chapter 13. We start with surrendering a vehicle, how that’s done, and why that might be better, or at least usually no worse, in a Chapter 13 case.
Avoiding a “Deficiency Balance” through Bankruptcy Discharge
You have a major advantage in surrendering your vehicle to the vehicle lender when filing bankruptcy. That advantage is that you get to legally and permanently write off—“discharge”—whatever balance you owe—the “deficiency balance.” Without a bankruptcy discharge you would have to pay that “deficiency balance” after giving up your vehicle.
The “deficiency balance” is the amount you owe on your vehicle loan after your lender credits to your account the proceeds of the sale of your surrendered vehicle and debits the costs of that sale. This “deficiency balance” is usually much more than you expect. That’s because your lender tends to sell the vehicle at an auto auction for much less than you’d expect. And the expenses of the sale pile up more than you’d expect—auction fees, storage fees, extra late charges, etc.
The end result is that even when you think your vehicle is worth about what you owe, you could still end owing thousands of dollars of a “deficiency balance” after surrendering your vehicle.
Disadvantages under Chapter 13
If you give your vehicle up to your lender in a Chapter 7 case, the “deficiency balance” will be discharged quickly—usually only about 3 months after you file your case. In contrast, in a Chapter 13 case the discharge only happens at the end of the payment plan. That’s almost always between 3 to 5 YEARS after you file the case. The vehicle lender can’t try to collect the debt in the meantime. But during this time while this debt is in limbo at the very least you delay getting a fresh start on your credit record.
Also, the discharge of the “deficiency balance” doesn’t occur AT ALL unless you successfully complete the Chapter 13 payment plan. For countless reasons debtors do not successfully complete a certain percentage of Chapter 13 cases. So there’s this risk to contend with.
Lastly, in a Chapter 13 case most of the time you pay the “general unsecured” debts a certain percentage of the total owed. A “deficiency balance” would be one of your “general unsecured” debts. Why pay something on that debt when you don’t pay anything in a Chapter 7 case?
If You Need Chapter 13 for Other Reasons
In spite of these seeming disadvantages, Chapter 13 would still be better for you in many circumstances.
First, you may have major reasons to file a Chapter 13 case nothing to do with your vehicle loan. It may enable you to save your home. It may give you the best way to deal with a huge amount of income taxes you owe. There are many other potential reasons to file a Chapter 13 case. Dealing with your vehicle debt may be a minor issue in the big picture.
Big Timing Advantages
Second, Chapter 13 gives you a great timing advantage that Chapter 7 simply can’t give you. It lets you try to keep your vehicle and then decide to surrender it later. Down the line you may not be able to afford to pay for the vehicle after all. Months or even a couple years after filing your case your income may go down or expenses may go up. The vehicle may turn into a “lemon,” or need too many expensive repairs. It may get into an accident. You may no longer need the vehicle as much or may be able to get a less expensive one.
Pretty much at any point in your 3-to-5-year Chapter 13 case you can decide to surrender your vehicle. At that point any “deficiency balance” becomes part of your “general unsecured” debts. It gets discharged at the end of your case.
The longer you wait more the more likely the “deficiency balance” will be less, because you will have paid off more of the vehicle debt. Still it’s a significant advantage to be able to hedge your bets somewhat by being able to surrender later.
Usually You Don’t Pay Anything More under Chapter 13 Because of the “Deficiency Balance”
We raised the question above, why pay anything on the “deficiency balance” under Chapter 13 when you can pay nothing under Chapter 7? One answer is that in practical terms you usually don’t pay anything more in your Chapter 13 case if you owe a “deficiency balance.”
How can that be when usually a Chapter 13 case pays at least some percentage of the “general unsecured” debts?
First, in SOME cases the debtor pays NONE of the “general unsecured” debts, 0% of the amount due.
Second, in MOST cases the debtor ends up paying a fixed amount into the pool of “general unsecured” debts. That fixed amount is a based on how much the debtor can afford to pay all of his or her debts during the period of time the case lasts. Some of the money usually goes first to other legally more important debts. The amount left over is divided pro rata among all the “general unsecured” debts, including the “deficiency balance.” The existence of the “deficiency balance” does not change the amount the debtor pays towards the “general unsecured” debts. It only changes who gets paid how much within that pool.
For all these reasons, it makes sense to surrender a vehicle to its lender in a Chapter 13 case.