If your car is worth less than what you owe on it, you may be able to use a Chapter 13 bankruptcy “cramdown” to reduce the balance and interest rate on your car loan.  Read on to learn what a cramdown is and how it works in Chapter 13 bankruptcy.

What Is a Car Loan Cramdown?

After you buy a car, it begins to depreciate (lose its value) very quickly, especially if it was new. This means you may end up with a car loan balance that is greater than what your car is worth.  However, you may be able to reduce your loan balance down to the value of your car through a Chapter 13 bankruptcy.  This is referred to as a cramdown.

How Does a Cramdown Work?

Cramdowns are available in Chapter 13 bankruptcy only -- you cannot cram down a car loan in Chapter 7 bankruptcy.  In a Chapter 13 bankruptcy, you propose a repayment plan to pay back your creditors over a three to five year period. (To learn how Chapter 13 bankruptcy and the repayment plan work, see the articles in our Chapter 13 Bankruptcy topic area.) In your plan, you have the ability to propose that your car lender receive only the value of your car instead of the entire loan balance if certain conditions are met.

For example, say you took out a $30,000 loan to buy a new car in 2008. Now it is 2011 and the car you bought has depreciated in value to $10,000 but your loan balance has only gone down to $20,000.  This means that only $10,000 of the loan is “secured” because if the lender repossessed your car and sold it, it would only receive $10,000 (this is the car’s replacement value).  This is where a cramdown can help you.

In your Chapter 13 plan, you can propose to pay only the replacement value of the car to your lender.  So in the above example you can cram down the balance of your loan to $10,000 (the value of your car) and tell your lender this is all you are going to pay.

What About The Remaining Balance of My Car Loan?

What happens to the unpaid portion of your loan?  It will receive the same treatment in your Chapter 13 plan as your other nonpriority unsecured debts such as credit cards and medical bills. Since most Chapter 13 plans pay little or nothing to these creditors, this means that your car lender will likely receive nothing or pennies on the dollar on the remaining balance of your loan.  At the completion of your plan, any unpaid balance of the loan will be discharged and wiped out and you will own the car free and clear.

Additional Benefits Of A Cramdown

When you cram down a car loan in Chapter 13 bankruptcy, the law also allows you to lower your interest rate on the loan.  The interest rate will be determined by your specific bankruptcy court but it will generally be the prime rate plus a little extra.  In most cases, this will be lower than your original car loan rate. 

Limitations On Using a Car Loan Cramdown

In order to prevent people from buying new cars and cramming down their loans shortly thereafter, Congress has placed an important restriction on when you are allowed to cram down a car loan.  To take advantage of a car loan cramdown, you must have purchased the car at least 910 days (about 2 ½ years) before you filed for bankruptcy.