Using Sequestration to get Free Through Chapter 13 Bankruptcy Your right to file for bankruptcy was carved into the Constitution by the founding fathers of this nation in Article 1 Section 8 of the Constitution, before the right to free speech and the right to bear arms. Our market economy relies upon the acquisition of debt to allow us to purchase homes, automobiles, and take chances as entrepreneurs. Families plan their budgets, including what debt is manageable, according to their planned income. Under sequestration, the Border Patrol personnel have faced reductions in income from 25-30% through no fault of their own. Those debts that were once manageable can now seem absolutely insurmountable.
Chapter 13 of the Bankruptcy Code allows individuals with regular income to settle debts with creditors for a fraction of what is owed. The bankruptcy process bunches debt into two basic categories, secured and unsecured. “Secured” means the value of property secures the debt, and “unsecured” means there is no property that can be taken to satisfy the debt. In bankruptcy, secured creditors interest are protected, but unsecured creditors may only get a percentage of what they’re owed. In short, secured debt stays the same throughout the bankruptcy process, while unsecured debt may be reduced through bankruptcy to give relief from what would otherwise be an impossible financial situation. But the bankruptcy laws can be used to change how some debts are defined and treated in the bankruptcy process.
In a Chapter 13, the individual’s disposable monthly income (DMI) determines the amount paid back to creditors. DMI is found by taking the net income of the individual and deducting living expenses. The Bankruptcy Code requires monthly payments in a bankruptcy plan for 60 months, and so the total amount you can repay is determined by multiplying your DMI by those 60 months. Once you repay that amount, you are left with your secured debts and absolved of your unsecured debt.
Two especially important aspects of bankruptcy, available through Chapter 13, allow debts that at the start are secured to be shifted to the unsecured debts. Allowing for a more manageable amount of debt after a successful bankruptcy, the first is lien stripping, and the second is the car value cramdown.
Lien Stripping Getting rid of that second lien. Lien stripping allows you to challenge the value of secured debt when you have more than one lien on the property and are underwater on the first lien. This bankruptcy tool is especially relevant in today’s housing market where many homeowners owe more on a first loan than the value of the property. In this situation, where the individual has two liens, and is underwater on the first, the Bankruptcy Code allows the debtor to shift the second one out of the “secured” category, and add it to the “unsecured” category. Let’s take the example of someone with a first and second mortgage. You have a first for $500,000, and a second for $200,000. The value of the home is $499,000.00. The Code allows you to strip off that second mortgage and make that $200,000 join the unsecured debt. Once you have paid off the amount required by the plan, you are freed from your 2nd mortgage.
This applies not only to homes, but also to automobiles or any other item you purchase with a security agreement, such as an RV, boat, or other items in which you might have two liens.
Car Value Cramdowns Two ways to get ahead. The car value cramdown changes the value of the secured debt owed on a car in two ways. The amount the dealer paid to pay off your old car’s loan when it was traded in, the negative equity, can be changed from the “secured” column to the “unsecured” column. In addition, the car loan can be crammed down to the present day value of the car. When a new car is purchased through a trade-in, and the buyer owed more on the old car than the trade-in value, many times the car dealer will pay off the outstanding amount, and add the paid off amount to the loan on the new car. This amount is called the negative equity in the new car, and the shifting of this amount to the “unsecured” column is the focus of the negative equity cramdown. For example, you trade in your old car for $6,000, but you still owe $10,000 on it. The new car is only $16,000, so the car dealer pays off the remaining $4,000 you owe and adds it to the loan for the new car. You now have a car worth $16,000 and a loan for $20,000. Through bankruptcy, you can cram down the amount of the loan to the value of the car, $16,000, and take the $4,000 and add it to the unsecured debts.
The second car value cramdown follows the demands of bankruptcy law that any secured claim by a creditor is only secured to the extent of the value of the property. In short, it gets the amount of the loan secured by the car to be recognized at the present day value of the vehicle. So that same car that cost $16,000 is now a few years old and Blue Book has it listed as only being worth $9,000. Different courts use different means to find the present day value, but we’ll use Blue Book to keep it simple. So, at the start of the filing for bankruptcy, the car’s value is $9,000 and the loan is still at $16,000. Through bankruptcy the “secured” claim by the dealer can be crammed down to the value of the car, $9,000, and take the $7,000 and add it to the unsecured debts.
So now take our example individual with $100,000 in unsecured debt with a DMI of $300. The total amount of repayment is $18,000 and so we have an 18% plan. To start, the individual has $720,000 in secured debt that will ride through bankruptcy and not be reduced like the unsecured debt. After the lien stripping and car value cramdown, the unsecured debt becomes $311,000 and the secured debt is now only $509,000. Through bankruptcy, $211,000 has been changed from secured debt to unsecured debt which shares in a portion of the plan’s $18,000. The plan is now a 3.5% plan. The individual will now come out of Chapter 13 with only the first loan on the house, and the loan on the car will only be for the present value of the car and won’t include the value of the old trade-in car. Most importantly, $311,000 of unsecured debt is taken off the shoulders of the individual, and they can have a fresh start. Once you’ve paid your $18,000, you have your home, your car, and freedom from your unsecured debts.
Sequestration’s impact on income, although painful, offers a short window of opportunity to get out from under crushing debt as never before. Bankruptcy offers individuals affected by this horrible legislation the tools necessary to reduce their unsecured debts, and return them to a position where they can get back to responsible debt management.
As the foremost bankruptcy attorney in San Diego, The McMillan Law Group is the first choice for anyone seeking financial freedom. Call Alan at 858-499-8951