A creditor’s rights over you in either Chapter 7 or 13 vastly increase if it has a security interest. Now’s the time to find out for sure.
Reaffirmation vs. Cramdown
The last four blog posts have compared Chapter 7 reaffirmation with Chapter 13 cramdown of a secured debt.
With reaffirmation you keep the vehicle or other collateral but continue to owe the debt. Usually you owe the full debt, and the monthly payments remain the same. But sometimes the debt and monthly payments can be reduced if the collateral is worth less than the balance.
With cramdown you keep the collateral and usually pay less monthly and les overall. The debt is divided into secured and unsecured portions. The secured portion is equal to the value of the collateral; the unsecured portion is the rest of the debt. You pay the secured portion over time, with monthly payments usually less than the usual contract amount. Often the interest rate is reduced as well. The unsecured portion you pay only to the extent you can afford to do so during your Chapter 13 plan. Whatever you can’t pay is discharged—permanently written off.
Reaffirmation apples only to Chapter 7 “straight bankruptcy.” Cramdown applies only to Chapter 13 “adjustment of debts.”
A Valid Security Interest
Both reaffirmation and cramdown are needed only with debts that are legally secured against something you own. Your creditor must have a valid, legally enforceable security interest in something you own. Otherwise the debt is just a general unsecured debt. If so you could discharge that debt without paying anything to the creditor. You don’t have to enter into a reaffirmation agreement to pay the debt in full or in part. You don’t have to pay the secured portion in a cramdown if the debt is not secured at all.
Consider this example. Assume you took out a personal loan of $6,000. You agreed to give the lender a security interest in all your furniture. But the creditor does not have you sign anything but a promissory note. That’s an agreement to pay the debt. The creditor does not have you sign a security agreement or anything else stating that you are backing up the debt with a right to the furniture if you don’t pay the debt.
Then a year later you file a bankruptcy case.
Effect of No Security Interest in Bankruptcy
Assume that the amount owed on the debt is now $5,500, and your furniture has a replacement value of $3,000.
If you file a Chapter 7 case you could very likely simply discharge that debt without paying anything. And the creditor would have no right to your furniture.
If instead this creditor DID have a security interest in the furniture, one of three things would likely happen in a Chapter 7 case:
- If you wanted to keep your furniture, the creditor could insist that you agree to pay the debt under the original monthly payment and all the other terms of the loan.
- Acknowledging that the furniture was not worth the amount of the debt, the creditor could reduce the amount reaffirmed to closer to $3,000, and maybe reduce the monthly payments.
- You could surrender the furniture to the creditor and pay nothing.
In a Chapter 13 case one of two things would likely happen:
- If you wanted to keep your furniture, through cramdown you’d pay $3,000 plus (possibly reduced) interest. You’d pay the remaining $2,500 if and to the extent you could afford to do that in your payment plan.
- You could surrender the furniture to the creditor and pay the remaining debt if and to the extent you could.
So you can see that the creditor has infinitely more leverage when its debt is secured than when it’s not. This is true in both Chapter 7 and 13.
Determine If a Debt is Really Secured
The key lesson in this is to find out whether debts you think are secured really are. Most of the time if you think a creditor has a security interest in something, it actually does. But sometimes your understanding about this ends up being wrong. So talk with your bankruptcy lawyer about each one of your seemingly secured debts. Now is the time to find out whether your assumption is wrong and/or a creditor has neglected to make its debt a legally secured one.