How bankruptcy treats secured and unsecured debts

If you are having debt problems, you may be considering bankruptcy as a way to address them, but are unsure of how filing it would affect your debts. If you feel this way, you are certainly not alone. Although the answer to this question is complex, most of it depends on whether the debt in question is a secured or unsecured debt.

What are the differences between the two debt types?

Secured debts include your mortgage, car loan and other debts where your promise to repay the debt is secured by collateral. In the event that you fail to repay your secured debt, your creditor may take back the collateral and sell it to pay off your debt. In cases where the creditor is unable to sell the collateral for your debt amount, he or she may have the right to sue you for the difference between the sale price and your debt amount (also known as the deficiency).

Unsecured debts, on the other hand, include debts where there is no collateral involved. If you fail to pay an unsecured debt, your creditors generally may not immediately take any property. However, creditors may sue you in court, put a lien on your property or hire a collection agency to encourage you to pay your unsecured debt. Common examples of unsecured debts include credit cards, rent, medical bills and personal loans.

What will bankruptcy do to each debt type?

Both types of debt are treated differently in bankruptcy; the fate of each depends on the type of bankruptcy you file. In Chapter 7, most unsecured debts are wiped out within months after filing.

During Chapter 13, on the other hand, unsecured debts become part of the payment plan. Under the plan, you make monthly payments towards your debt over 3-5 years. However, with unsecured debt, the law only requires you to repay your unsecured debts to the extent that you would have under Chapter 7. Since this amount is zero in the majority of cases, most unsecured debt is wiped away at the conclusion of Chapter 13.

Regarding secured debts, Chapter 7 generally will discharge your obligation to repay the debt. However, it does not affect your secured creditor's ability to take back the collateral. Because of this, you must stay current on your secured debts throughout Chapter 7 in order to keep the collateral. However, if you would like to surrender the collateral, Chapter 7 can protect you from being sued for the deficiency, if the collateral sells for less than your debt.

Chapter 13 also does not discharge your secured debt. However, it allows you 3-5 years under the payment plan to catch up with all missed payments. As long as you make the required installment payment towards your overdue secured debt each month, Chapter 13 prevents your creditors from repossessing the collateral. This protection is especially useful if you are facing foreclosure, as it can give you the time needed to save your home. Once you complete Chapter 13, you have caught up with your overdue payments and resume making your normal payments towards your secured debt that you made before you filed bankruptcy.

Questions? Seek legal help

There are several exceptions to these general rules. In order to obtain a complete picture of how bankruptcy would affect your situation, speak with an experienced bankruptcy attorney. An attorney can analyze your unique circumstances and advise you on the best way out of your debt problem.