Secured Debt Versus Unsecured Debt In Bankruptcy Cases

In bankruptcy cases, understanding the difference between secured and unsecured debt is crucial, as it affects how each type of debt is treated and managed during the bankruptcy process. Here’s a detailed overview of both types of debt:

Secured Debt

Definition: Secured debts are loans or credit for which the borrower pledges collateral to the lender. This collateral secures the loan, giving the lender a legal claim to the asset if the borrower defaults.

Examples:

• Mortgages: The property (house) serves as collateral.
• Auto Loans: The vehicle serves as collateral.
• Secured Credit Cards: A deposit serves as collateral for the credit limit.

Treatment in Bankruptcy:

• Chapter 7: In Chapter 7 bankruptcy, secured creditors have a right to repossess or foreclose on the collateral if the debtor is unable to continue making payments. Debtors may choose to reaffirm the debt (agree to keep paying) or redeem the collateral by paying its current value.
• Chapter 13: In Chapter 13 bankruptcy, debtors can include arrears in their repayment plan, which allows them to catch up on past-due payments over three to five years. The debtor continues to make regular payments on the secured debt outside the plan.

Implications:

• Secured creditors have a higher priority because of their claim on the collateral.
• Failure to pay secured debts typically results in the loss of the collateral.

Unsecured Debt

Definition: Unsecured debts are loans or credit extended without specific collateral. These debts are based solely on the borrower’s creditworthiness and promise to repay.

Examples:

• Credit Card Debt: Typical credit cards without collateral.
• Medical Bills: Debts incurred for medical services.
• Personal Loans: Loans not backed by collateral.
• Utility Bills: Outstanding payments for utilities like electricity and water.
• Student Loans: Often considered unsecured, although they have specific rules for discharge.

Treatment in Bankruptcy:

• Chapter 7: In Chapter 7 bankruptcy, unsecured debts are typically discharged, meaning the debtor is no longer legally required to pay them. However, some unsecured debts, like student loans and certain taxes, are not dischargeable under most circumstances.
• Chapter 13: In Chapter 13 bankruptcy, unsecured debts are included in the repayment plan. The debtor makes payments based on their disposable income, and remaining unsecured debt may be discharged after completing the plan.

Implications:

• Unsecured creditors do not have a claim to specific assets.
• These debts are prioritized lower than secured debts and are often paid off at a lower percentage in bankruptcy.

Key Considerations

1. Automatic Stay:
   • Upon filing for bankruptcy, an automatic stay goes into effect, temporarily halting all collection activities from both secured and unsecured creditors. This provides immediate relief to the debtor and time to reorganize or liquidate their finances.
2. Reaffirmation and Redemption (Chapter 7):
   • Debtors can choose to reaffirm secured debts, agreeing to continue making payments, or redeem the collateral by paying the current market value, thus retaining the asset.
3. Cramdown (Chapter 13):
   • In some cases, Chapter 13 allows for a cramdown on secured debts (excluding mortgages on primary residences). This means the loan balance can be reduced to the collateral’s current value, with the remaining balance treated as unsecured debt.
4. Non-Dischargeable Debts:
   • Certain debts, whether secured or unsecured, are not dischargeable in bankruptcy. These include child support, alimony, certain taxes, and student loans (except in cases of undue hardship).

Resources for Further Information

• United States Courts – Bankruptcy Basics: Offers comprehensive information on the types of debt and their treatment in bankruptcy.
  • US Courts – Bankruptcy Basics

Understanding the distinction between secured and unsecured debts and how they are treated in bankruptcy can help individuals navigate the bankruptcy process more effectively and make informed decisions about their financial future.