Upside Down on Car Insurance – Chapter 13 Cram Down Provisions and Chapter 7 Redemption

Customers often find themselves in need of debt relief due to a defaulted car insurance.

Contemporary society requires owning and maintaining a car which sometimes turns into a devastating financial burden. Lenders are rushing to finance vehicles knowing that borrowers are prioritizing moving cars over most other financial obligations. Even borrowers with bad credit are fitted into auto financing packages with high interest rates to compensate lenders eager for the extra risk.

Financial difficulties often arise from car financing. The happy car buyer drives his new car from the almost 100% financed plot of land. As the saying goes, almost immediately after that, the value of a new car drops by several thousand dollars before it even hits the highway.

Automobile transportation costs from $4000.00 to $6000.00 annually including auto insurance payments, liability and collision insurance, repairs, maintenance, and gasoline.

Havoc begins when an unexpected out-of-warranty car repair, or car accident, unexpectedly and dramatically causes the car to drop in value well below the insurance balance owed to the bank. Or, perhaps more pernicious, at a new car swap where enthusiastic auto salespeople and lenders agree to take your old car at the trade-in, throwing the remaining balance of your old car insurance (to pay a slightly higher amount) on the back end of the new car insurance makes the new car buyer” upside down” significantly when buying a new car.

These situations leave the borrower in a bind as large portions of the income are allocated to cover an unsecured car debt obligation that does not pay off the modest costs of family necessities.

Under certain circumstances, relief from these devastating financial predicaments can be obtained by filing for bankruptcy.

Chapter 13 Provisions Down CRAM

Under Chapter 13 of the United States bankruptcy code, debtors are allowed to “lower” the unsecured portion of their auto insurances to the fair market value of the vehicle securing the insurance. This requires debtors to pay off only the secured portion of the car insurance, but the unsecured balance is treated as an unsecured general creditor that provides significant interest to the debtor, allowing the debtor to pay back only a small portion of the unsecured portion of that auto insurance debt owed.

For example, let’s say our debtor owns a car of $10,000.00 and there is a car insurance with a repayment balance of $20,000.00. In this scenario, the insurance is only partially secured. The auto lender is only guaranteed up to the value of the car or $1,0000.00. The remaining balance of $10,000.00 on the insurance is unsecured. In this case, the bankruptcy law gives the debtor the right to cut off the unsecured portion of the car insurance and treat that portion of the insurance as unsecured. So, if the unsecured general creditors only receive a 20% dividend, the auto lender would get only $2000.00 on the unsecured portion of the auto insurance.

These situations become sticky between the debtor and the lender because disagreements often arise over the correct value of the vehicle. Your bankruptcy attorney will need to negotiate a settlement over the appraisal before confirming the debtor’s Chapter 13 plan.

The assessment is guided by provisions of US bankruptcy law, specifically 11 USC § 506 – Determination of Safe Status.

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

“If the debtor is an individual in a case under Chapter 7 or 13, that value is determined with respect to personal property that secures an allowable claim on the basis of the alternative value of such property as of the date of the petition without deduction for selling or marketing costs. With respect to property acquired for purposes Personal, family or household, the replacement value means the price charged by the retailer on property of this type considering the age and condition of the property in time value asserted”

The Cram Down clause under the bankruptcy law also provides for a lower rate of interest on an auto insurance. Debtors often find themselves shelling out huge car payments that are used to cover the exorbitant interest rates that auto lenders often charge risky borrowers.

An interesting exception was enacted under 2005 amendments to the United States bankruptcy law that prohibit underpayment where a car money purchase insurance was created within 910 days (two and a half years) from the date of filing for Chapter 13 bankruptcy [see 11 U.S.C §1325(a)(9)]. Debtors should consider the timing of a Chapter 13 filing if they wish to escape the burdensome debt burden of a car insurance. Bankruptcy rules require auto insurances taken out within two and a half years of filing for bankruptcy to be repaid as agreed.

Chapter 7 Redemption

Chapter 7 (or “direct bankruptcy”) bankruptcy practices are not permitted. But, Chapter 7 debtors are allowed to “redeem” their personal property under 11 USC §722.

11 USC §722 states:

“An individual debtor may … redeem tangible personal property intended primarily for personal, family or household use, from a mortgage that secures a non-rechargeable consumer debt, if such property is exempted under section 522 of this title or is relinquished under section 554 of this right , by paying the holder of such lien the amount of the secured claim permitted to such holder and secured by such lien in full at the time of redemption.” Confirmations added

However, repayment may be difficult under Chapter 7 because the debtors must advance a full cash amount sufficient to repay the secured portion of the auto insurance measured at the vehicle’s fair market value at the time the debtor seeks to repossess the vehicle. Chapter 7 does not allow for a insurance to be restructured, but sometimes an auto lender will accept payments over time, but usually within a short period.


If the value of your car is less than what you owe it, bankruptcy options can be helpful in giving you to keep your car and move towards better financial health.

Chapter 13 can reduce or “shrink” your insurance balance and interest rates and thus lower your automatic payment making it more affordable. Chapter 13 also enables you to restructure past due auto payments and spread them over the term of your Chapter 13 plan so that you can make up for past due payments within your personal financial means.

Chapter VII bankruptcy does not accommodate insurance repayment restructuring, but the recovery provisions of Section 722 allow debtors to purchase their vehicles after bankruptcy for the vehicle’s fair market value, leaving the unsecured portion of the debt repaid under Chapter VII bankruptcy.