When it comes to filing for bankruptcy, one of the key considerations for individuals and businesses is the distinction between unsecured and secured debts. As a bankruptcy attorney, it is important that all clients understand the key differences between these two types of debts and understand how they will be handled in the bankruptcy process. In knowing the major differences, clients are better equipped to choose the right bankruptcy for their individual case. This blog will explore the differences between secured and unsecured debt and how each is treated in the bankruptcy process.
Differences between Unsecured and Secured Debts
In order to understand how bankruptcy impacts secured and unsecured debts, it is important to first understand the distinction between unsecured and secured debts. Unsecured debts are those that are not tied to any specific asset, such as credit card debt or medical bills. So long as there is no evidence of bankruptcy fraud, these types of debt will be discharged (eliminated) through the bankruptcy process after the case is completed. Nevertheless, it is important to understand that some unsecured debts, such as student loans or taxes, are not dischargeable in bankruptcy. Of course, whether a debt can be eliminated or not will also depend on the type of bankruptcy being filed, your income, and equity in assets, but this gives you a general idea of how unsecured debts are treated.
Secured debts, on the other hand, are those that are tied to a specific asset, such as a mortgage or car loan. For example, if you own a home and you owe a mortgage, the mortgage would be considered a secured debt because the repayment of the mortgage is “secured” by the home. Therefore, if you fail to make mortgage payments, the mortgage holder has the right to foreclose on your home. Financing a vehicle works in the same way – this repayment of the debt is secured by the vehicle. If you stop making car payments, the car will be repossessed.
Secured Debts and Bankruptcy
One of the key considerations for individuals and businesses when deciding whether to file for bankruptcy is the type of bankruptcy that should be filed and how it will impact the secured debts.
In some cases, individuals or businesses may choose to surrender their assets in order to have their secured debts discharged. For example, if an individual or business is struggling to make payments on a car loan, they may choose to give up the car and have the debt discharged through Chapter 7 bankruptcy. This can be a difficult decision, but it may be the best option for those who can no longer afford the payments on the secured debt. This is because, unlike a voluntary repossession where you would still be obligated to pay the bank the balance of the loan (even after returning the vehicle), when you surrender a vehicle through a bankruptcy, the balance owed on the loan is discharged upon completion of the case.
On the other hand, if you own a home, have fallen behind on mortgage payments or car payments, but you want to keep the home or car, you can file a Chapter 13 bankruptcy to stop any possible foreclosure action or vehicle repossession, and use the Chapter 13 Plan of Reorganization to payback the amount you fell behind.
Reaffirmation of Debt
Another option you may have when dealing with secured debts in bankruptcy is the concept of “Reaffirmation of Debt.” This is the process of agreeing to continue paying off a secured debt after the bankruptcy is completed and all other debts have been discharged. This is often done to keep an asset, such as a home or car. Essentially, you are signing a contract where you are voluntarily choosing to continue to make payments on a car or home as you have been prior to the filing of the bankruptcy. However, it is important to carefully consider the financial implications of reaffirming a debt because you are voluntarily taking on the continued obligation to pay the debt, and this can have a significant impact on your post-bankruptcy finances.
Cramdown of Secured Debt
It's also important to note that in a Chapter 13 bankruptcy, the debtor can "cramdown" the balance owed on a car loan. The term “cramdown” is a legal term of art, but the basics are simple: you pay the creditor the value of the asset. For example, if an individual purchased a car for $20,000 and still owes $18,000 on the loan, but the current fair market value of the car is only $15,000, the debtor can propose a plan to the court to pay only $15,000 on the car loan through the Chapter 13 bankruptcy plan. This is known as a "cramdown" of the loan balance. However, in order to qualify: i) the case must be a chapter 13 case; ii) the car can’t be a commercial vehicle; and iii) the car loan must have originated more than 910 days prior to the filing of the bankruptcy.
Conclusion
In conclusion, the impact of bankruptcy on secured debts can vary depending on the type of bankruptcy case filed and the state laws. It's important to work with a bankruptcy attorney to understand how your specific secured debts will be impacted by the bankruptcy process and to make the best decision for your unique financial situation. Surrendering an asset may be a difficult decision, but it may be the best option for those who can no longer afford the payments on the secured debt. If you are in debt, and whether you need someone to explain how bankruptcy works and how you can rebuild your credit after bankruptcy, we are well qualified as a full-service law firm for people in this county and other New Jersey counties: Passaic County, Hudson County, Essex County, Bergen County, Morris County, Union County, and Sussex County. Call us today at 973-554-9827 or toll free 973-696-8391.
Resources
For further information on the bankruptcy process and the differences between secured and unsecured debt, you can visit any of the websites below:
- The U.S. Department of Justice's website (justice.gov) provides information on the bankruptcy process, including the treatment of unsecured and secured debts.
- The U.S. Courts website (uscourts.gov) has a section on bankruptcy, and discusses the different types of bankruptcy, the process for filing for bankruptcy, and the treatment of unsecured and secured debts.
- The American Bar Association's website (americanbar.org) has several articles and resources on the treatment of unsecured and secured debts in bankruptcy.
- The National Consumer Law Center's website (nclc.org) has a section on bankruptcy, with information on the treatment of unsecured and secured debts in bankruptcy, as well as resources for consumers.
- The Legal Information Institute at the Cornell Law School website (law.cornell.edu) has a section on Bankruptcy Law, with various articles on the treatment of unsecured and secured debts in bankruptcy.
- The National Association of Consumer Bankruptcy Attorneys (nacba.org) has a section on consumer bankruptcy, with information on the treatment of unsecured and secured debts in bankruptcy and resources for consumers.
