The Costs and Benefits of Surrendering Collateral in Chapter 13

Chapter 13 buys you flexibility when you want to keep your home or vehicle, but might need to surrender it after all.  But it’ll cost you.

 

The Simple Surrender

If you’ve decided to surrender your home, vehicle, or any other collateral that you no longer need or want to pay for, filing a Chapter 7 “straight bankruptcy” is usually the cleanest way to go. The remaining debt on the home is mostly either discharged (legally written off)—including 2nd mortgages, judgments, utilities—or is paid off by the mortgage holder after taking back the real estate—such as property taxes and homeowner association dues.  On your vehicle loan, the often large “deficiency balance”—the amount you would owe after the creditor sells the vehicle and applies the sale proceeds to the loan balance—is discharged. You give up the collateral but you are quickly free of the debt.

The Possible Delayed Surrender

But what if you want to keep your home or vehicle, and yet have reason to think that you won’t be able to in the long run? For example, what if you know that your job may not last for more than another year, so you’re sensibly facing the reality that at that point you would likely not be able to continue makign payments on the home or vehicle?

Under Chapter 7, if you were behind on the home mortgage you would usually have to catch up on the back payments in a matter of a few months. Same thing with a vehicle loan, expect you would likely have only a month or two to catch up. In contrast under Chapter 13, you generally have three to five years to catch up on back mortgage payments. And with vehicle loans, you usually don’t need to catch up at all on missed payments, and the monthly payments are often even reduced.

So with both home and vehicle, you would very likely pay less into the obligations on the front end under Chapter 13. That means that if your income is greatly reduced a year later, so that you need to surrender the home or vehicle, you would have paid less to keep possession of it while you had it.  This may have made it more feasible to have saved some money during that span of time for potential moving costs if you need to move or for some cheap replacement transportation if you surrender your vehicle. Then if you do lose your job, your Chapter 13 plan could be amended, you may qualify for a hardship discharge, or your case could be converted into a Chapter 7 one. Which option would be the best for you depends on all your circumstances at that time.

But if instead you are able to keep your job or get another one with similar income, you would likely be able to continue following your Chapter 13 plan, keeping the home or vehicle, with the benefit of spreading out your cost for doing so.  

Flexibility at a Price

Chapter 13 costs more in fees than Chapter 7, easily triple the cost, or more. The attorney fees are much higher because of the significantly more effort involved over a period of years instead just of a few months. Plus the Chapter 13 trustee receives a percentage of what you pay to the creditors. So what you may save by paying less in mortgage or vehicle payments may be partially or even fully offset by these higher fees.

Also, after the surrender of the home or vehicle you may decide to stay in the Chapter 13 case, because you could have other reasons for doing so, such as to pay some taxes or catch up on back child support while under bankruptcy protection. If you stay in Chapter 13, under some circumstances you may be required to pay a portion of the debt remaining on the surrendered home or vehicle. That would often not increase the total amount you would pay into your Chapter 13 case (because the other creditors may simply be paid that much less), but this is something you should discuss with your attorney.

And maybe most importantly, Chapter 13 is a much more complicated and lengthy solution compared to the streamlined and quick Chapter 7. Looking at the big picture it’s very seldom worthwhile to enter into a Chapter 13 case if you are not going to finish it successfully. So realize that in the right set of circumstances it can give you some flexibility and maybe some cost savings. But you need to carefully consider with your attorney whether the delay in your “fresh start” and the other possible downsides are worth those potential benefits.

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