Secured vs. unsecured debt in bankruptcy
Both secured and unsecured debts are treated differently in bankruptcy.
One of the top questions people have about bankruptcy is what will happen to their debts once the process has been completed. Although this is a simple question, the answer is rather complicated. In reality, the fate of a person’s debts depends on the type of debt that they are carrying-secured or unsecured-as each type is treated differently in bankruptcy.
As the name implies, secured debts are debts where a promise to repay the debt is secured by a pledge of collateral. Common examples of this type of debt are car loans and mortgages. When a secured debt is not paid, the creditor can take and sell the collateral to pay off the remaining balance of the debt.
Conversely, unsecured debts involve no pledge of collateral. As a result, if this type of debt goes unpaid, the creditor may not take any property. However, even though this is the case, the creditor is far from powerless. In many cases, creditors collect unsecured debts by filing a lawsuit against the debtor in order to garnish his or her wages. Examples of unsecured debts include medical bills, credit card debt and personal loans.
Bankruptcy’s treatment of each debt type
As mentioned earlier, secured and unsecured debts are treated differently in bankruptcy, depending on the type of bankruptcy filed. If Chapter 7 bankruptcy is filed, most unsecured debts are quickly discharged, eliminating the legal obligation to repay them. However, secured debts are left largely untouched by Chapter 7. Although Chapter 7 discharges the debtor’s personal liability to repay them, it does not affect the creditor’s right to repossess the collateral if the debt remains in arrears. Because of this, debtors wishing to keep the collateral throughout Chapter 7 must stay (or quickly become) current on their secured debts.
In Chapter 13 bankruptcy, both debt types become part of the payment plan to be repaid in monthly installments over three to five years. However, under the plan, most unsecured debts only need to be repaid to the extent that they would have been if Chapter 7 had been filed instead. Since this amount is essentially nothing, most unsecured debts are not repaid under the plan and are discharged at the end of Chapter 13.
As far as secured debts go in Chapter 13, this type of bankruptcy also does not eliminate this type of debt. However, Chapter 13 does give the filer 3-5 years to become current on his or her secured debts. As long as the agreed monthly payment is made pursuant to the plan, secured creditors may not take the collateral. When Chapter 13 is completed, the debtor is caught up on the secured debts and returns to making the normal pre-bankruptcy payments on them .
Although it may seem enticing, bankruptcy is not always the best way to manage debt problems. As a result, it is important to consult with an experienced bankruptcy attorney before taking steps to address a crushing debt load. An attorney can walk you through your options and make a recommendation based on your unique situation.