Hi welcome to a special edition of our facts in five. Today we are going to talk about cram downs and bankruptcy. The reason this is the topic is because recently President Obama has come forward saying that homeowners should be allowed to use bankruptcy in order to cram down or reduce the amount they owe on their mortgage in a bankruptcy proceeding. As the law stands now, it is not permissible for a homeowner to reduce the amount of principal in a bankruptcy proceeding however, the concept of a cram down is nothing at all new to a bankruptcy.
There are two main reasons for a bankruptcy in all. The first is to protect the interest of the debtor, the person who owes money. Usually when someone owes money there are many different creditors that are pulling for their attention through phone calls, through letters through lawsuits, and these lawsuits can be done all throughout the country. Bankruptcy allows the debtor to go to a single court and to have that court protect them from the actions of the creditors while everything gets sorted out. But, bankruptcy is also intended to protect the creditor that is the person who lends the money. In a typical case, the quickest to the court house might get paid but not in bankruptcy. In bankruptcy similar creditors should be paid similarly that means if someone gets 20 cents on the dollar then everyone with the same kind of claim should get the same amount. Here is where the concept of cram down comes up.
In the case of say, a car, or machinery, a person who has a secured interest that is the creditor who usually lent the money in the first place to buy the product and has the product its self as collateral usually can take the item back, sell it and get that money in order to pay back the loan. Often times, the value of the collateral will be less than the value of the loan itself. In those cases, the law is pretty plain, the court will reduce the amount that the secured creditor will get repaid to the amount that they would get had they taken the collateral back and just sold it at auction. This protects the creditor’s interest up to the amount that they lent and the amount that they recovered. As for the left over money, that amount is paid just like any other unsecured creditor: someone who didn’t have collateral at all.
So, someone who lent $100 and now can go and sell the machinery for $50 will get their $50 claim paid in full but the remaining $50 will be paid the same amount that Chase, Capital One or any other unsecured creditors with credit cards would get paid.
The lone exception in a Chapter 13 Bankruptcy, the type that is made for consumers is either 1) for a car less than 2.5 years old or 2) for a principal residence. These assets cannot be crammed down in bankruptcy and the full amount must be paid to the creditor. The result of this has been in many jurisdictions including Arizona the large number of people who file for bankruptcy and are under water on their property are still required to pay the full amount through the bankruptcy. However, under the proposed law, in a Chapter 13 bankruptcy, a judge will be allowed to reduce the amount of the mortgage to the amount of the current market value. It’s unknown how that will be determined but it is likely that an appraisal will be needed and that will be presented to the judge in order for the judge to make a judgment about how much the loan will be reduced.
The law must be passed by congress before its effective simply because President Obama has proposed this doesn’t mean that the law will change at all. So, keep checking with the website and keep watching the news to see if cram downs in bankruptcy will be allowed. Then the Chapter 13 type of bankruptcy just might be right for you.