The Financial Effect of Surrendering Collateral in Chapter 13
If you are concerned that in a Chapter 13 case a debt resulting from surrendered collateral will cost you more, often it won’t.
Secured Debts in Chapter 13
In a Chapter 13 “adjustment of debts” case you have the option of keeping or surrendering collateral.
Whether it’s your home, your vehicle, or any other collateral, Chapter 13 gives you powerful tools for keeping that collateral.
But in spite of that, sometimes the best option is still to surrender that collateral. You may have overextended yourself buying a vehicle whose payments and insurance you can no longer afford. Or you’ve learned that it’s a lemon and not worth the constant repair costs. Or you bought a home that you’re so far behind on that it’s not worth the cost and effort to catch up, even if Chapter 13 gives you a lot of time to do so.
Secured Debts Turned into Unsecured Ones
So Chapter 13 gives you the option of just surrendering the vehicle or home or other collateral to the creditor. That has the effect of turning that debt from a secured debt into an unsecured one. The creditor usually accepts possession of the vehicle or home, sells it, and, if the sale proceeds do not satisfy the debt, you may owe the remaining balance.
Outside of bankruptcy, if you are liable on that “deficiency balance,” you’d have to pay it. You’d be sued for payment if you didn’t pay. In a Chapter 7 “straight bankruptcy,” that remaining unsecured debt would usually simply be discharged—legally written off. But what happens to that remaining debt under Chapter 13?
Dealing with the Remaining Unsecured Debt under Chapter 13
A Chapter 13 case usually involves a 3-to-5-year payment plan. At the end of the payment period, there’s a discharge of all or virtually all of your remaining debts.
In many Chapter 13 plans, much of the money paid out to creditors goes to special debts. Those special debts are either secured and priority debts. Secured debts are payments to creditors with liens on collateral you want to keep, as mentioned above. Priority debts are ones—usually unpaid income taxes and/or child or spousal support—that would not be discharged in bankruptcy and so need to be paid. In many Chapter 13 cases, most of the debtors’ disposable income goes to pay these secured and priority debts.
This often leaves relatively little money for the rest of the debts—the unsecured, non-priority ones. Sometimes, it leaves no money at all for these other debts—0% of the amounts owed.
But there are also some Chapter 13 cases—usually ones with relatively little secured and priority debts—in which the plan provides for paying a large percentage of the other debts. There are even cases which require paying 100% of the unsecured debts.
But these are rare. Much more common are plans paying a low percentage of the unsecured debts. Chapter 13 requires payment of all disposable income to creditors during the course of the 3-to-5-year case. Often that simply doesn’t leave much left for the unsecured debts.
Surrendering Collateral Seldom a Financial Disadvantage
Without understanding how Chapter 13 really works, it may seem like a disadvantageous way to surrender collateral. Why pay even just part of the remaining unsecured debt after surrendering collateral when you can just discharge that debt in a Chapter 7 case without paying anything?
There are in fact good reasons not to mind surrendering collateral in a Chapter 13 case:
- You wouldn’t be in a Chapter 13 case unless it gave you a big advantage for other reasons. For example, you may be willing to surrender a vehicle you really didn’t need if Chapter 13 gave you great way to save your home. There are many, many reasons that Chapter 13 is better than Chapter 7. Paying a small part of the unsecured debt on the surrendered collateral may be well worth the other benefits.
- But in probably the majority of cases you would NOT be paying ANY more into your Chapter 13 plan because of a surrendered vehicle, home or other collateral. Why not?
- If you have a 0% plan as mentioned above, you’re not paying anything to any general unsecured debts. So adding the debt from the surrendered vehicle, home, etc. makes no difference. Paying nothing on a somewhat larger pile of debt is still nothing.
- Even if your plan IS scheduled to pay a certain percent of your general unsecured debts, it STILL doesn’t usually cost you more. That’s because in most cases you only have a certain amount of money available for the pool of all these debts. Adding another debt to that pool only spreads that same available money out among more debts. When you add the debt from the surrendered collateral, the other debts are just paid less.
Before you shy away from surrendering collateral in a Chapter 13, ask you bankruptcy lawyer if it will cost you any more to do so. In most cases it does not.