Secured Debts in Chapter 13 Bankruptcy

In Chapter 13, a debtor is generally entitled to keep his assets while repaying debts through a plan of reorganization. Amongst a debtor’s creditors there are different rights and priorities that affect the ownership of a debtor’s assets and the priority in which creditors get paid.

In order to be eligible to file for bankruptcy protection under Chapter 13 of the bankruptcy code, the amount of secured debt that an individual debtor can have is limited. The debt limit is $1,257,850 (the dollar amount is adjusted every three years for inflation; the next inflation adjusted amount is April 2022).

Secured debt is an obligation that creates an entitlement to recover against a debtor’s property if certain contractual provisions are or are not met. The property in which a secured creditor has an interest is called collateral and the interest is generally recorded as a lien against the collateral. A security interest can either be consensual (voluntarily given) in connection with a loan or payment for services rendered or nonconsensual as in the case of statutory, judgment or tax liens.

Mortgages and Secure Loans

The most common types of consensual secured debt are mortgages secured by a borrower’s home and purchase money loans secured by a vehicle or other valuable asset. Sometimes a single property can be used as security for more than one debt, such as a second mortgage on a home. In voluntary cases, one creditor may agree to subordinate (take lower priority) the loan below a senior creditor. Generally, as defined by state law, the first creditor to receive or record a security interest has higher priority than any future secured creditors.

Nonconsensual liens arise in a variety of circumstances, such as failure to pay real property taxes, failure to pay for services rendered on real property or equipment (e.g., a mechanic’s lien), or debts arising from an unpaid judgment against the debtor.

A secured creditor will generally recover what is owed before other pre-bankruptcy creditors. A secured creditor can seek relief from the automatic stay to take possession or sell collateral, under certain circumstances, including where a debtor does not have equity in the property, a debtor is not making payments on the debt or if the creditor is not otherwise adequately protected.

A Chapter 13 debtor, unlike those in Chapters 7 or 11, cannot modify a secured creditor’s interest in a debtor’s primary residence. This means that the maturity date, interest rate and monthly payments for a debtor’s home cannot be modified by the debtor’s plan. However, if the debtor had fallen behind on payments prior to filing for bankruptcy, Chapter 13 does allow the debtor to cure these missed payments over the 3-5 year repayment period of the plan.

Additionally, if a Chapter 13 debtor has a second or third mortgage in the residence and the value of the residence is less than or equal to the value of the first mortgage, a debtor can “strip” the junior liens. Lien stripping effectively transforms a junior lien holder’s claim into an unsecured claim that the debtor can treat in the same manner as other unsecured claims under the plan.

Chapter 13 Cramdown

A Chapter 13 debtor’s ability to alter a secured creditor’s treatment under a plan is less restrictive for assets other than the debtor’s primary residence. In certain circumstances, a Chapter 13 debtor can cramdown the claim of a secured creditor with an interest in the debtor’s vehicle or investment property. Cramdown allows a debtor to limit the secured portion of a creditor’s claim to the actual value of the collateral.

Explained another way, if a secured creditor is owed $1,000, but the collateral securing the debt is only worth $600 the secured creditor has a $600 secured claim and a $400 general unsecured claim. A Chapter 13 debtor is also able to change the terms of repayment, such as extending the payment period or reducing the interest rate. Cramdown is a very complicated area of bankruptcy law and any person considering the option would be best served by contacting an experienced bankruptcy attorney.

Case Studies: Secured Debts in Chapter 13 Bankruptcy

Case Study 1: Protecting the Family Home

John and Lisa, a married couple, faced financial difficulties due to unexpected medical expenses. They fell behind on their mortgage payments, and their home was at risk of foreclosure.

In their Chapter 13 bankruptcy filing, John and Lisa sought to save their family home while repaying their debts. This highlighted the importance of the automatic stay in preventing foreclosure and how Chapter 13 allowed them to cure missed mortgage payments over the repayment period, ultimately enabling them to keep their home.

Case Study 2: Stripping Junior Liens

Sarah, a single mother, had a primary residence with two mortgages. The value of her home had significantly decreased, and the outstanding balance on the first mortgage exceeded the property’s value.

In her Chapter 13 bankruptcy case, Sarah aimed to strip the junior lien held by the second mortgage lender. By successfully stripping the junior lien, Sarah turned it into an unsecured claim, allowing her to treat it on par with other unsecured debts under her repayment plan.

Case Study 3: Cramdown on a Vehicle Loan

Michael, a small business owner, financed a delivery van for his company. However, due to a decline in business, he struggled to make the monthly payments.

In his Chapter 13 bankruptcy filing, Michael sought to cramdown the vehicle loan, as the van’s value had depreciated significantly. Through the cramdown process, Michael was able to reduce the secured portion of the creditor’s claim to the actual value of the van, resulting in more affordable repayment terms.