For those who would make the unwise decision to roll the old car’s debt into the new car, yet another reason not to. Policy wonks may recall how during the Bush administration the banking industry got its fondest (pre-bailout) wishes granted. The bankruptcy rules were re-written to make it substantially more difficult for a normal person to discharge debt. (Interestingly, mansion owners in Texas and Florida somehow survived unscathed while the vast majority of bankrupts are still done in by medical bills.) The upshot is that fewer qualify for a full Chapter 7 discharge and more must file a Chapter 13 repayment plan. Here’s what that means for the “typical” car buyer.
Let’s say a woman buys a new 2004 Grand Am. Rolled into her “deal”: $5,980.00 of debt from her trade in. The total contract comes to $23,850.00 before interest and fees. It is a standard GMAC car loan contract. Two years later, the woman files for bankruptcy, which is no surprise if she makes deals like this one.
When she files for bankruptcy, as a creditor with a lien on property of any sort, she bears a risk of “cram down.” The loan amount will be adjusted (downward) to the actual value of the item with the lien. The exception (and there always is one): there’s no “cram down” in a chapter 13 if the debtor “reaffirms” the loan, for a house or a car. It is “secured” debt and given priority. (Debtor has to live somewhere and get to work so this is routine).
This becomes a crucial question to the GMACs of the world. The loan is worth, to the bank, either a) the cram down value, meaning that any overage is lost, or b) the whole loan amount, even if not directly attributed to the value of the car. In this case, the value of the Grand Am was $10,950.00. The lien amount was $17,904.00.
Reproduce this case by one hundred thousand and you see why this is not just a minor point of bankruptcy law. The finance company would have to eat all the bad decisions of debtors and unwise car finance contracts, as that debt would be “unsecured” and in most cases that means “unpaid.” This would also mean that depreciation of product would also come out of the creditor’s side, a not inconsiderable issue in today’s world.
The Second Circuit of the United States Court of Appeals reasoned that the loan, even if more than the car’s value, was part of the transaction between the parties, and as such, GMAC was entitled to full security for the full note, not just the value of the car. The dissent, which we can only hope prevails if the US Supreme Court ever hears this, reasons that the purpose of the security is to secure the product, not side deals or other loans.
The short answer here is that even if you file bankruptcy, an upside down car remains “upside down” and none of that debt can be discharged. This is a huge win for the banking industry. Even if you go bankrupt, there is no bailout for you!
“The short answer here is that even if you file bankruptcy, an upside down car remains “upside down” and none of that debt can be discharged”
More money for the speculators to play with, lose, then beg for bailouts – the circle is now complete.
Somebody wants to borrow more than they can pay back and GMAC lends them the money. Talk about dumb and dumber.
What is to stop the person going bankrupt from giving them their collateral back and making them eat the $6k of negative equity in the car?
Even with trashed credit you can get a $3-5k beater and be better off than reaffirming the massive debt overhang on the GM POS.
«vast majority of bankrupts are still done in by medical bills»
The interesting thing is, illness is also major driver of people not even being able to purchase for baby’s clothes, and having to rely on the charity of others… in Canada, where they have socialized medicine.
This sad short story about a 30 year-old Canadian suffering from skin cancer and the government botching up his case was just published this week:
A Different Kind of Bankruptcy
So, do you really think socialist medicine will keep the US from having bankrupt people? Think again, buddy.
Published twice by error. Deleted. Thanks!
I’m not pushing for socialized medicine (?), just pointing out the major source of personal bankruptcies. Running second are “business failure” and “divorce”.
My office is small. Buying Health insurance at this level is punitive but you are in a world with no choice. I’d be happy to see a standardized product (and so would the medical billing staff) with an open market of some sort. The current “employer based” model is from 1950 and as relevant. At least give me ‘car insurance’ level of choice…that’s how desperate it is out here for a small company.
If you find yourself bankrupt (and it is oft NOT moral failure) this is a big deal. The huge step of filing to discharge debt is not taken lightly. Pushing debtors into 13 instead of allowing 7 discharge is a big part, and GMAC getting priority on all their contracts is also a big deal. Living under a Chap 13 payback deal under the new rules is not great-minimum IRS values for things like food and shelter are assessed, penalizing anyone in an expensive area like NYC or LA.
With the average numbers on a bankruptcy petition, the few thousand in car debt per petition not subject to a reduction to the actual value of the vehicle will be a large part of the payback amount, and will serve to cut off that much in credit card debt paid back, if any.
The dissent, which we can only hope prevails if the US Supreme Court ever hears this, reasons that the purpose of the security is to secure the product, not side deals or other loans.
Now I understand the distinction between the “secured” portion and the “unsecured” portion of the auto loan, but I suspect the author would also include the difference in loan value and “book” value of the auto in question, thus eliminating a portion of the actual “secured” debt. His statement, “This would also mean that depreciation of product would also come out of the creditor’s side”, bears this out.
The “cram down” is exactly what the secured creditors of GM/Chrysler got when they were forced to play second-fiddle behind unsecured creditors, and the author is saying he wants more of the same?
For those of you (us) who have been responsible, apparently you’ve (we’ve) been wrong all along.
“Reap what you sow” has been turned on its head.
To vww12:
This is slightly off-topic, as your issue seems to be over socialised health-care instead of the bankruptcy laws.
However, as a Canadian, I feel compelled to respond.
First off I will admit, the health-care system here in Canada is far from perfect. It has its problems – wait lists are the biggest complaint, and unfortunatley the occasional error ( I doubt that US private health-care is perfect judging by the ads on TV for lawyers searching for a malpractice suit…).
And it is a little galling that drug addicts and bums get the same level of health care as wealthy tax payers.
But over all, it is a pretty good system. So I would encourage America to look at what we have and improve on it. But don’t just dismiss it out of hand. That would be just as foolish as the morons who loaned money to people who had no hope of paying it back (the dumb and dumber comment from Kendahl above).
Thanks, and have a great day.
This article is mostly wrong, or at best half-right.
For one thing, most people still qualify for a chapter 7. The kind of people who need to roll an old loan into a new loan for a 2004 Pontiac Grand Prix are the kind of people who typically qualify for a chapter 7. For severely upside down loans in a Chapter 7, you can “redeem” the vehicle, where you pay the fair market value (NADA value actually, least in my circuit) to the creditor and the rest is discharged. See 722redemption.com for a company that does this. The interest is very very high, but if the principal is reduced enough it works. You cannot do a cramdown in a chapter 7. You redeem, reaffirm (take it as it is), or surrender.
In a 13 in the case you cited, you would be able to cramdown a car bought in 2004, and would do it as a matter of course. The problem is that the 2005 reform made it so that a loan made to purchase a vehicle cannot be crammed down within 910 days after it was bought. So a 2007 Pontiac Grand Am wouldn’t be crammable, and that’s when the roll over amount can’t be gotten rid of.
Hope that makes sense. The only situation where this decision would matter would be:
1) Debtor has to file a 13 for whatever reason
2) Debtor rolled over an old loan into a new car purchase within the last 910 days
And of course the debtor always has the option of just surrendering the car if its so badly upside down.
The worst case I’ve ever heard of was a woman who ended up owing 40,000 bucks on a Ford Focus after she rolled the old car loan into it.
Also, fyi, never buy a decked out F-150 new. Wait a year or two and save 20 grand. Those things fall off of a cliff.
Also, no, medical bills are not what tip most people into bankruptcy. If anything that is the rarest of the major causes of bankruptcy, which are stupidity, poverty, failed business, lost job, trying to live on social security alone, divorce, and medical bills (not in that order necessarily). The average debtor typically has a few small medical bills they didn’t pay. People with significant medical expenses aren’t as common as you’d think.
A new car dealer just sold my niece a $23,000 Kia (!) for $0 down and a six year note financed through him ( I think that’s an additional $1K profit). She’s 22, a student (w/school loans), and works P/T for barely $15K/year.
So it comes down to this: She owns nothing but the clothes on her back and we all know that her car WILL be repo’d. She won’t even have to file for bankruptcy. So, my question is: does she walk away scott free with nothing but a destroyed credit score?
The bankruptcy rules were re-written to make it substantially more difficult for a normal person to discharge debt.
The bankruptcy rules were re-written to make it substantially more difficult for anyone with income above the median for their zip code to discharge debt. You can decide whether the top half of households in income is a definition of “a normal person.”
Interestingly, mansion owners in Texas and Florida somehow survived unscathed
The bill couldn’t affect state homestead exemptions, as it was federal, but it did make it much more difficult for people to move to Texas or Florida immediately before declaring bankruptcy.
while the vast majority of bankrupts are still done in by medical bills.
This is incredibly false, but Elizabeth Warren keeps repeating it. The majority of people in bankruptcy had some sort of medical bill, but Warren’s study counted someone who had $5000 total in medical bills as a “medical bankruptcy” even if they had, e.g., lost their job, or had a mortgage that they couldn’t afford, or any other problem that may have been more significant. Here’s one discussion, but you should try reading the paper itself.
For example, if you look at the study, you’ll see that in only 29% of cases did the person in bankruptcy even say that medical bills were the cause of bankruptcy, but someone that gets expanded to over 60% of bankruptcies being medical because Warren disagrees with the debtors’ own opinions of what caused the bankruptcy.
One of her earlier studies (and perhaps this one) also counted gambling debts as medical, since a gambling problem is a medical one. (Also alcoholism.)
Yeah, most people in bankruptcy have medical bills, but that doesn’t mean that medical bills were “the cause” of the bankruptcy.
My question is, why do we permit loans to be secured by vehicles in the first place?
It is basically reckless for loans to be secured by a mobile, difficult to maintain, and rapidly depreciating asset.
It is even more reckless for our state governments to be the bag-man for this operation by recording and enforcing liens, with all the wild-west attitude of the repo men that follows these liens.
Let’s face it, a car loan is a given on the personal character of the borrower–and nothing else.
Without vehicle liens, people would be more likely to buy according to need.
Whatever happened to only lending the loan value of a car? Many years ago I worked for a short time as a car salesman. A customer could only get the book loan value for a car loan against a new or used car.
On a new car, loan value was generally well below dealer invoice on a new car. The idea of course was that the actual cash value of the vehicle should be enough to cover the loan. New car buyers had to either come up with enough cash or enough equity in their trade to make the deal. Rarely did we sell a new car to someone until after the loan on their previous car was already paid off.
Lending over $23k against a new 2004 Grand Am would never have happened under the old rules of the game.
Irresponsible banks pushing financial crack to undisciplined buyers. No wonder the house of cards fell.
Everybody rides, your job is your credit.
Now we all get to pay for it.
Sigh.
Patrickj :
June 27th, 2009 at 11:18 am
My question is, why do we permit loans to be secured by vehicles in the first place?
It is basically reckless for loans to be secured by a mobile, difficult to maintain, and rapidly depreciating asset.
That’s a great question, and here’s a rational answer: by securitizing the note, the lender can offer a better interest rate, which benefits the buyer and the seller.
Obviously, for the lender, this makes sense as well…they have a piece of property to sell and recoup part of their loss in the worst case scenario. For unsecured lenders, they take a 100% loss if the borrower declares Chap 7.
Based on this, I think it’s a GREAT idea to securitize car loans for everyone. The trick is to do it responsibly, which wasn’t the case too often.
And the car has to carry comprehensive insurance, further lowering the risk for the lender. Seeing as how it’s been done this way for 10000 years there is nothing plainly wrong with the concept, it’s just been enhanced with debt from a previous car.
People took 125% mortgages out too. That was just as dumb from a financial point of view for the lender.
I think GMAC should take a haircut because they assumed the risk of the loan, but that isn’t how it works any longer.
We may like to point out that something occurred during the bush administration, but in fact congress voted this in. A bilateral joint congress, repubs and dems all-in. Whenever both parties join in near-unanimous legislation with mighty urgent promises of resulting justice, citizens better watch their wallets. Whether in bankruptcy reform, immigration reform, TARP bailouts, you name it.
Make them pay cash for everything up front. Most are freeloading sacks of shit that will cheat their mother for two dollars.
My issue is that repossession of a car from somebody who probably hasn’t opened the hood in a year isn’t recovery of a valuable asset, in the way that taking back a house is. Even if the house is destroyed in a way invalidating the insurance, the bank will make a substantial recovery from the land, utilities, and foundation.
After expenses, a repoed car might get back a third the value of a car note for 90% of MSRP–and many car notes are for a lot more than that.
Car repossession is a means of imposing a major inconvenience on the person who doesn’t meet their obligations. Nothing at all wrong with that, but it’s not appropriate security for a $35,000 loan.
ronin writes about the Bankruptcy Reform Bill of 2005:
We may like to point out that something occurred during the bush administration, but in fact congress voted this in. A bilateral joint congress, repubs and dems all-in.
Sorry, but this really is something we can pin on the Republicans. Clinton pocket-vetoed a version of this bill in 2000, and the enhanced position of the Republican party after the 2004 elections was the thing that revived its fortunes. The vote was admittedly not very close in the end (a good number of Dems did join the bandwagon), but when more than 125 Congressmen dissent on a bill, you can’t call it “near-unanimous.”
Regarding the wisdom of securing loans against cars (using the word “securitized,” as an earlier poster did, is a misnomer — that refers to bundling and splitting consumer loans or home mortgages into marketable bonds, “securities,” not to securing debt through a claim on a particular asset), I come down on the side of “it makes commercial sense.” At least it did when sane underwriting practices prevailed.
Lending only up to the actual value of the car, minus some margin of equity, and then putting the loan on a repayment schedule that is quick enough to keep the thing above water, should have been obvious and immovable bedrock principles of auto lending. That way the lender really does have security against massive losses on default, though the costs of repo and selling the car quickly at auction may make for slight losses. If a lender doesn’t follow these rules, then he really is just lending on the personal credit of the buyer, with the added “inconvenience effect” that goes along with a possible car reposession — and that is obviously much weaker security.
I feel a bit of “they should reap what they sow” when it comes to GMAC and the other big auto finance companies. I don’t see why they were systemically important to the banking sector and deserved a bailout. They should have gone bust and their executives turned out of doors, and saner banks and credit unions could have picked over the pieces (call centers, back office departments, dealer connections) and stepped in to supply auto loans. If that meant a month or two of even slower sales this year because of lack of credit, then so be it — we were propping up the auto companies at that point anyway, and we need to get consumer lending back on a sound basis in this country sooner rather than later if this crisis is going to end.
I own my car free and clear. Of course, it is a 15 year old Panther platform heap with ~185k miles on the clock and a long list of minor problems that I never get around to fixing. But it has character. And did I mention that I own it free and clear?
Amazing bankruptcy bullshit.
What I did after college:
57 Bel Aire HT only and last new car purchased on installment payments. Lesson learned.
The only other new car was a 65 VW Bug paid for at purchase.
All others were two years old (about) and paid for at purchase. Two Fords sold when they were 21 years old with 150k miles.
Two were salvaged and repaired cars. The 89 Mazda 626 was the best value car.
I DIY most mainteance.
A car never had priority over work, family, retirement.
Bankruptcy attorney friend of mine explained when the rules changed, it eliminated a safety valve, that is contributing to the financial implosion. People are hanging in much longer and getting deeper in trouble.
It is even more reckless for our state governments to be the bag-man for this operation by recording and enforcing liens
Well actually…. the state has a deep financial interest in this. They earn sales tax, and licensing revenue from car sales. So providing the legal infrastructure to secured loans benefits the state by driving sales, which drives tax revenue.
Tighter lending laws will clear up a lot of this. If there is reason to believe you can’t pay, then take a bus!
I have a REPO lot near my house, and I’m always amazed at the tricked out vehicles they have in there. A guy’s bastard kid may not have a house to live in, but his dad even with just a job at Best Buy sure had a sweet ride!
NBK-Boston: Sorry, but this really is something we can pin on the Republicans.
Considering what posters who actually know and understand bankruptcy law are saying about the bill, it hardly seems that bad.