Secured vs. Unsecured Debt: How Bankruptcy Affects Them

Understanding the differences between secured and unsecured debt is crucial when navigating the complexities of bankruptcy. These two categories of debt are treated differently under bankruptcy law, which can significantly impact the strategy used in both filing for bankruptcy and planning for financial recovery. As a bankruptcy attorney in New Jersey, I regularly assist clients in distinguishing these debts and explaining how each is affected by bankruptcy filings. This article will clarify these differences and explore how bankruptcy can reshape your obligations to secured and unsecured creditors.

What is Secured Debt?

Secured debts are those backed by collateral. This means a specific asset, such as a house or car, guarantees the debt. The creditor holds an interest in the collateral until the debt is paid off. If you default on a secured debt, the creditor has the right to repossess or foreclose on the collateral to recover the owed amount.

Common examples of secured debt include:

• Mortgages
• Car loans
• Home equity lines of credit

What is Unsecured Debt?

In contrast, unsecured debts do not involve any collateral. These creditors do not have rights to any specific asset if you fail to make payments. Instead, they may seek repayment through other means such as suing you and obtaining a court judgment.

Typical unsecured debts include:

• Credit card bills
• Medical bills
• Personal loans
• Utility bills

Treatment of Secured Debt in Bankruptcy

Chapter 7 Bankruptcy:

• In Chapter 7, also known as liquidation bankruptcy, non-exempt assets may be sold by the bankruptcy trustee to repay creditors. Secured creditors have the priority to be paid from the proceeds of the sale of the collateral securing the debt. If the sale does not cover the full amount of the debt, the remaining debt may be discharged, depending on your circumstances.
• Debtors can choose to reaffirm the debt, which means they agree to continue paying the debt under the existing terms and keep the collateral. Alternatively, debtors can surrender the collateral to the creditor and discharge any remaining debt associated with the asset.

Chapter 13 Bankruptcy:

• Chapter 13 allows debtors to keep their secured assets through a restructured repayment plan. This plan consolidates debts and extends the repayment period, potentially lowering the monthly payments. Secured debts can be prioritized in the plan, ensuring that payments towards these debts continue, which allows debtors to avoid repossession or foreclosure.
• In some cases, Chapter 13 can also involve “cramdown” of a secured debt where the loan amount may be reduced to the current value of the collateral. This is common in car loans or other personal property loans but not applicable to mortgages on the debtor’s primary residence.

Treatment of Unsecured Debt in Bankruptcy

Chapter 7 Bankruptcy:

• Unsecured debts are generally discharged at the end of the bankruptcy process in Chapter 7. This means that once the bankruptcy is finalized, the debtor is no longer legally required to pay off the discharged unsecured debts.
• Certain unsecured debts like alimony, child support, and student loans are typically non-dischargeable, meaning they cannot be wiped out in bankruptcy.

Chapter 13 Bankruptcy:

• In Chapter 13, unsecured debts are incorporated into the repayment plan. Debtors may end up paying a fraction of these debts depending on their disposable income and the total amount of their debt.
• At the end of the repayment plan period, most remaining unsecured debts are discharged, except for the non-dischargeable debts mentioned previously.

Take Control of Your Debt Today

The treatment of secured and unsecured debt in bankruptcy varies significantly and impacts your decision on which chapter of bankruptcy to file. Understanding these differences is crucial for effectively managing your debts and planning your financial recovery. If you’re considering bankruptcy, consult with a knowledgeable bankruptcy attorney who can provide advice tailored to your specific financial situation, helping you make informed decisions about managing your secured and unsecured debts.