Consumers dealing with large debt and minimal prospects of repaying that debt often turn to bankruptcy to get a fresh start. Through the bankruptcy, the debtor can emerge debt-free and not have to live with collection calls and worries.

The United States Bankruptcy Code (the “Code”) is confusing. What’s more, there are various types of bankruptcies to choose from. For a consumer debtor, the choices are either between a Chapter 7 or Chapter 13 bankruptcy.

For Chapter 13 bankruptcy, the Code provides for the right to cram down and lien strip a loan. During a cram-down the debtor converts a portion of a debt from secured to unsecured status. In effect the amount of the secured debt is “crammed-down” to the actual value of the property. Similarly, lien stripping is converting the entire debt from secured to unsecured status. Conceptually, cram down and lien stripping are the same in Chapter 13.

As will be explained, converting debt from secured to unsecured is a big deal in bankruptcy law.

Chapter 7 v. Chapter 13

Chapter 7 is also called “straight bankruptcy” because of its nature to sell certain items, pay off some or most of the debt, and then emerge debt-free. It is a straight forward process and can be utilized by just about anyone.

Chapter 13 is also called “wage earner’s plan” because it is only available to those who earn a wage. It is generally  more complicated than Chapter 7 and is not available to those who are unemployed

Cram down and lien stripping discussed

As mentioned, a cram-down the debtor converts a portion of a debt from secured to unsecured status. The amount of the secured debt is “crammed-down” to the actual value of the property. For instance, a $12,000 car loan secured by a car valued at $5,000 can be crammed-down to a $10,000 secured debt. Additionally, a high interest rate may be crammed-down to an interest rate approved by the bankruptcy court. This modified debt is paid over the life of the bankruptcy case, which would be either three or five years.

Similarly, lien stripping is the conversion of an entire debt from secured to unsecured status. When a lien on a property is wholly unsecured, the lien is stripped off and made unsecured. For instance, assume that a home has three debts: $100,000 is owed on a first mortgage, $30,000 is owed on a second mortgage, and $10,000 is owed on a judgment, for a lien total of $140,000. Assume the fair market value of the hose is $90,000. The second mortgage and judgment lien are not secured by any value in the home. The bankruptcy court can convert the secured status of the second mortgage and judgment lien to unsecured status, thereby placing payment of these stripped debts with the unsecured debt.

Chapter 13 advantage

The power to cram down and lien strip is advantageous for a debtor. One significant advantage is the ability to modify the rights of a secured creditor. This means the debtor can actually change the terms of a contract with a creditor through bankruptcy .

Debts subject to cram down

Cramdown is limited to certain types of secured debts, such as furniture or a vehicle. The cramdown provision cannot be used for a first home mortgage. Note, however, that it may be used for a second mortgage or vacation home.The asset must be personal property and, depending on the type of asset, there may be a minimum period of time that must have passed from the time the debtor took out the loan on the item before cramdown is permitted.

Timeframe

Provided that the debtor purchased the item he wishes to cram down at least a year ago then it is possible to cram down the debt. Recently purchased items are not eligible for cram down or lien strippingAs long as you made your purchase at least a year ago, you can defeat this creditor leverage. You are allowed in effect to rewrite the terms of the debt based on the value of the collateral. For automobiles, the time frame is at least 910 days.

What Happens to the Unsecured Part of the Debt

The unsecured portion is lumped together with other “general unsecured” debts. This pool of debt only gets paid when the debtor, as approved by a judge, is able to pay. Besides for secured debt, administrative expenses like attorney’s fees go before payment of the unsecured debt. Often, Chapter 13 debtors pay no payments to the general unsecured party.

In debt? Find out more about Chapter 13 Bankruptcy from the law office of Melanie Tavare, a bay-area consumer bankruptcy attorney.