Secured vs. Unsecured Debts in Bankruptcy

One of the top questions people ask about bankruptcy is what will happen to their debts. Although the answer to this question can be complicated, in general it will depend on the type of debt-whether it is secured or unsecured. Knowing how each type of debt is treated during bankruptcy can help you assess whether it would be a good fit for you.

What is the difference between debt types?

Each type of debt is treated differently by creditors and in bankruptcy. Secured debts are debts that are secured by a pledge of collateral. Common types of secured debts include mortgages and car loans. If you are unable to pay a secured debt, your creditors may take and sell the collateral to pay off your debt. If the sale price is not high enough to cover your debt, the creditor may then sue you to obtain a judgment for the unpaid amount ("the deficiency").

Conversely, unsecured debt involves no pledge of collateral. Since collateral is absent in this type of debt, creditors generally may not take any property if the debt is unpaid. However, creditors may file a lawsuit against you or sell the debt to a collection agency to coax you into paying the debt. Common unsecured debts are medical bills and credit card debt.

What happens to each type in bankruptcy?

As mentioned earlier, the fate of each type of debt is different in bankruptcy and largely depends on the type of bankruptcy filed. In Chapter 7 bankruptcy, most of your unsecured debt will be discharged, freeing you of your obligation to repay it.

However, Chapter 7 affects your secured debt differently. Although it can relieve you of your personal liability for the debt, it does not affect your creditor's right to retake the collateral. Because of this fact, if you would like to keep the collateral in Chapter 7, it is necessary to stay current on the payments. However, if you do not want the collateral, Chapter 7 can protect you from being sued for the deficiency.

If you file Chapter 13, on the other hand, both debt types become part of the repayment plan. Under the plan, you repay your debts in monthly installments over three to five years. However, the plan only requires you to pay your unsecured creditors the amount they would have received in Chapter 7. Since most unsecured creditors receive nothing in Chapter 7, you do not need to fully repay most unsecured debts in Chapter 13. Because of this fact, most unsecured debts end up discharged after only pennies on the dollar (if even that much) are paid towards them.

With regard to secured debt, Chapter 13 can give you the help you require to become current. Filing Chapter 13 does not discharge your secured debt. However, it does give you three to five years to catch up on your secured debts. While you are making payments, you can keep the collateral. Also, your creditors may not repossess the collateral during this time. When Chapter 13 ends, you are current on your secured debts and resume making your regular payments toward them, assuming that you have not paid them off by this time.

Although these rules may seem simple, in reality there are many exceptions. If you are struggling with debt, you are well advised to consult with an experienced bankruptcy attorney. The attorneys at Minnillo & Jenkins, CO. LPA can give you a detailed analysis of how bankruptcy would affect your unique situation and offer guidance on how to proceed.