Upside Down on Car Loan: Chapter 13 Cram Down Provisions and Chapter 7 Redemption

Clients frequently require debt relief as a result of a bad car loan.

Owning and maintaining a car in today’s society is essential, but it can become a crippling financial burden. Given that borrowers place a high priority on their need for transportation, lenders are quick to finance vehicles. Even those with poor credit are accepted into auto financing plans with high interest rates to make up for the increased risk posed by aggressive lenders.

Auto financing frequently results in financial difficulties. Happy with their purchase, the new car owner drives it off the lot with almost 100% financing. As the saying goes, almost immediately after purchase, the new car loses several thousand dollars in value before it even leaves the lot.

The annual cost of car transportation ranges from $4,000 to $6,000 and includes gas, repairs, maintenance, liability and collision insurance.

When a motor vehicle accident or an unexpected car repair that is not covered by the manufacturer’s warranty significantly reduces the value of the car below the outstanding loan balance owed to the bank, chaos ensues. Or, perhaps more harmlessly, on a trade-in for a new vehicle, where eager car salespeople and lenders agree to accept your old vehicle on trade, and throw the remaining outstanding balance from your old car loan (for a little higher payment) on the back-end of your new auto loan, leaving the new car buyer significantly “upside-down” on the new vehicle purchase.

These circumstances put the borrower in a difficult situation where a sizable portion of their income is used to pay off an unsecured auto debt obligation that is useless for sustaining modest costs of necessities for family living.

The filing of a bankruptcy petition may be the only way to find relief from these dire financial situations in some cases.


The unsecured portion of auto loans can be “crammed down” by debtors under Chapter 13 of the United States Bankruptcy Code to the fair market value of the vehicle serving as the loan’s security. Debtors are only required to pay back the secured portion of the auto loan; however, because the unsecured portion is treated as a general unsecured creditor, the debtor can pay only a small portion of the remaining debt on the unsecured portion of the auto loan.

As an illustration, suppose our debtor has a car worth $10,000 and a $20,000 auto loan with a $20,000 payoff balance. This situation only has partial security for the loan. Only as much as the vehicle’s value, or $10,000.00, is the auto lender secured. The loan’s remaining $10,000.00 balance is unsecure. The Bankruptcy Code gives the Debtor the option in this case to sever the unsecured portion of the auto loan and treat it as such. Therefore, the auto lender would only be paid $2,000 on the unsecured portion of the auto loan if General Unsecured Creditors were only receiving a dividend of 20%.

Because there are frequently disputes regarding the proper value of the vehicle, these situations become difficult for the Debtor and Lender to handle. Before the Debtor’s Chapter 13 plan is confirmed, your bankruptcy attorney must negotiate a settlement regarding the valuation.

The United States Bankruptcy Code, specifically Section 11 U.S., provides guidelines for valuation. Determination of Secured Status under Section 506 of the Code.

11 USC §506(a)(2) specifically states:

“If the debtor is an individual, the value of any personal property used to secure an approved claim in a chapter 7 or chapter 13 case will be calculated using the replacement value of the asset as of the petition filing date, net of any sales or marketing expenses. With respect to property acquired for personal, family, or household purposes, replacement value shall mean the price a retail merchant would charge for property of that kind considering the age and condition of the property at the time value is determined” emphasis added

A reduction in the auto loan’s interest rate is also allowed by the bankruptcy code’s Cram Down provision. The exorbitant interest rates auto lenders frequently charge risky borrowers force debtors to make large auto payments to cover them.

When the purchase money auto loan was originated within 910 days (2 12 years) of the filing date of the Chapter 13 bankruptcy, an interesting exception to the United States Bankruptcy Code’s 2005 Amendments prohibiting cram downs was enacted [see 11 U.S.C. 1325(a)(9)]. If a debtor wants to get rid of their heavy auto loan debt, they must think carefully about when to file for Chapter 13. According to bankruptcy laws, auto loans obtained within two and a half years of filing for bankruptcy must be repaid in full.


Chapter 7 bankruptcy, also known as “straight bankruptcy,” prohibits cram downs. But under 11 U.S.C., Chapter 7 debtors are allowed to “redeem” personal property. §722.

11 U.S.C. §722 provides as follows:

“A single debtor could… redeem tangible personal property intended primarily for personal, family, or household use, from a lien securing a dischargeable consumer debt, if such property is exempted under section 522 of this title or has been abandoned under section 554 of this title, by paying the holder of such lien the amount of the allowed secured claim of such holder that is secured by such lien in full at the time of redemption.” emphasis added

The secured portion of the auto loan must be paid off in full up front in a lump sum of cash, which must be sufficient to cover the vehicle’s fair market value at the time the debtor wants to redeem it. This makes redemption under Chapter 7 challenging for some debtors. Restructuring a loan under Chapter 7 is not permitted, but the auto lender may occasionally accept payments made over time, though usually within a short period of time.


If you owe more money on your car than it is worth, filing for bankruptcy may be an option that will allow you to keep your car and get back on the road to financial stability.

Chapter 13 can lower your loan balance and interest rates, or “cram them down,” making your auto payment more manageable. Additionally, Chapter 13 gives you the option to restructure past-due auto payments and spread them out over the course of the Chapter 13 plan so that you can afford to make up missed payments within your own financial capacity.

Despite the fact that Chapter 7 bankruptcy does not permit restructuring of loan repayments, the 722 redemption provisions permit debtors to buy their vehicles out of bankruptcy for the fair market value of the vehicle, leaving the unsecured portion of the debt discharged under Chapter 7 bankruptcy.

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