Secured and unsecured debt: why it matters in bankruptcy

If you are in debt and are considering filing bankruptcy, one of the foremost questions on your mind is likely what will happen to your debt during the process. Although this question is simple, the answer depends heavily on whether your debt is secured or unsecured. Having a basic understanding of how each debt type is treated in bankruptcy can help you decide whether bankruptcy is right for you and which type of bankruptcy you should file.

Debt differences

Secured debts are debts where your promise to repay is secured by the pledge of collateral. With secured debts, if you fail to keep up with the payments, your creditor can take back the collateral securing the debt. Mortgage and car loans are common types of secured debt.

Once the creditor has taken back the collateral through foreclosure or repossession, it is sold to pay the unpaid portion of the debt. If the price at which the collateral is sold does not fully cover what you owe on the debt, the creditor may have the right to sue you for the amount (called the deficiency).

With unsecured debt, there is no collateral securing your repayment. Because of this, your creditors normally may not take any property if you fall behind. However, creditors have the option of suing you and asking the court to allow garnishment of your wages to force you to repay. Additionally, creditors may opt to turn over your debt to a collection agency or put a lien on certain types of property in certain cases. Common unsecured debts include credit cards, medical bills, rent and personal loans.

What happens to each type in bankruptcy?

Each debt type is treated differently, depending on the type of bankruptcy filed. If you file Chapter 7, most of your unsecured debts are wiped out, relieving you of the obligation to repay them.

However, Chapter 7 does not affect secured debts the same way. Although Chapter 7 can eliminate the obligation to repay the debt, it does not affect the creditor's lien that allows for the collateral to be retaken and sold. Because of this, if you would like to keep the collateral, it is vital to keep your secured debts current throughout the Chapter 7 process. However, if you would like to surrender the collateral instead of keeping it, Chapter 7 can protect you from being sued, if the collateral later sells for less than the debt amount.

During Chapter 13, most unsecured debt becomes part of the repayment plan to be repaid over three to five years. However, the amount that the law requires you to pay towards your unsecured debts is the same that you would have had to pay towards them, had you filed Chapter 7, which is nothing in most cases. As a result, most unsecured debts are discharged at the end of Chapter 13 after little or nothing has been paid towards them.

With regard to secured debts, Chapter 13 does not discharge the underlying debt. However, it does allow you three to five years to become current on your secured debts through the payment plan. This is why this type of bankruptcy is especially helpful for those seeking to avoid repossession or foreclosure. As long as you make the agreed monthly payment towards your delinquent secured debt under the plan, your creditors are legally prohibited from taking back the collateral. Once the payment plan has been completed, you are up-to-date on your secured debts and resume making your pre-bankruptcy payments towards them.

Although these rules seem simple, there are several exceptions to them. To learn about how your individual situation would be affected in bankruptcy, speak with an experienced bankruptcy attorney.