Unsecured Debt Versus Secured Debt in Bankruptcy
A Simple Explanation by the Experienced Bankruptcy Lawyers at the Law Offices of Jon G. Brooks in San Jose, CA
The Bankruptcy, whether we are talking about Chapter 7 or Chapter 13, unsecured debts and secured debts are treated very differently. Whether a debt is unsecured or secured depends on whether the debtor agreed in writing at the time he or she took on the debt to pledge some property as collateral for the loan. For some types of loans, such as a home mortgage loan or an auto loan, the pledging of the collateral (e.g., the home or car, respectively) is obvious. For others, it is not. For example, the electronics retailer Best Buy is infamous for offering what nearly any consumer would understand to be a store credit card while including what they purport to be a security agreement buried in the fine print of their credit card application, which they contend means that whatever the cardholder purchases with this credit card is automatically pledged as collateral for their revolving credit card.
We are all familiar with the two most traditional secured debts: home mortgages and auto loans. If a borrower defaults on a car loan, the lender will repossess the car (and sue later for the difference). If a homeowner defaults on a mortgage loan, the lender will foreclose on the home.
The distinction Between Unsecured Debt and Secured Debt Put Simply
In bankruptcy, the distinction between unsecured debt and secured debt is critical. We like to put it quite simply for our clients: with respect to secured loans, if you want to keep the collateral (e.g., the car, or the home), you must come current on the loan, and you must continue to pay on the loan during and after bankruptcy. This is true in both Chapter 7 bankruptcy and in Chapter 13 bankruptcy. For the most part, neither chapter of bankruptcy does anything to alter the amount due on a secured loan or the security interest in the collateral held by the lender. There are some very limited exceptions to this rule, however. These include the possibility of “stripping” a junior lien on real property in Chapter 13 (as we discuss in our article on lien stripping) and “cramming down” the amount owed on an auto loan to the current fair market value of the vehicle, which is also only available in Chapter 13 (and which we discuss in our separate article on auto loan cram downs).Our bankruptcy attorneys often explain that bankruptcy is very good at getting rid of most unsecured debts, while secured debts must continue to be paid so long as the debtor desires to retain the collateral securing the loan.
In Chapter 7, barring some factor that would make an unsecured debt nondischargeable (such as debts incurred through fraud, family support obligations, restitutionary damages for drunk driving, or tax debts and student loans—although taxes and student loans may dischargeable in very limited circumstances), all unsecured debt is discharged. In Chapter 13, unsecured debt is the lowest priority of debt in terms of repayment, and in most cases, the Chapter 13 payment plan will provide for only a portion of the total unsecured debt to be repaid, and the Chapter 13 debtor will obtain a discharge of the remaining unsecured debt at the completion of the payment plan. See our article on the Chapter 13 “Liquidation Test,” however, concerning one situation in which more unsecured debt may have to be repaid in a Chapter 13 plan.
As for secured debts, we sometimes see clients for whom bankruptcy may only offer limited relief. When the debt is a home loan, and the debtor needs a reduction in monthly payments or overall principal debt in order to keep the home, bankruptcy does very little to help the debtor keep the home.
In the end, if the client wants to keep collateral such as a car or home that is collateral for a secured loan, the client will generally have to pay the full amount of the balance of the loan with the limited exceptions described above. On the other hand, if the client is willing to voluntarily surrender the car or the home, then any remaining debt associated with that collateral becomes unsecured and can either be discharged outright in Chapter 7 or some portion may be dischargeable after completing a Chapter 13 bankruptcy payment plan.
To find out whether bankruptcy can help you with your secured and unsecured debts, contact one of our experienced bankruptcy attorneys in San Jose for a free consultation. Please call us at 408.286.2766. Prior to our appointment, we ask that you download our Personal Bankruptcy Questionnaire, fill it out to the best of your ability, and bring this information with you to your meeting.