When you prepare your bankruptcy paperwork, you'll need to sort your bills into three categories: secured, unsecured, and priority debts. A creditor who would like to get paid through your bankruptcy must also identify the type of debt when filing a proof of claim in your case. In this article, you'll learn the differences between debt types.
In bankruptcy, the debt type determines several things, including:
These responsibilities also vary depending on if you file for Chapter 7 or Chapter 13 bankruptcy. If you aren't sure which chapter is best for you, start by learning about the differences between Chapter 7 and 13.
This type of obligation is guaranteed by property known as "collateral." The debt contract gives the lender an ownership interest in the collateral called a "lien." The lien remains until the borrower repays the loan. If the borrower defaults on the loan, the lender can use the lien rights to recover the property.
Here are some examples of secured debt.
If a creditor has a lien on your property, then you owe a secured debt. The creditor has a secured claim.
Because the secured creditor has a payment mechanism in place, if money is available to distribute to creditors, a secured creditor won't get a part of it. The secured creditor already has a payment mechanism in place. Specifically, the remedy is to recover the property—usually through foreclosure or repossession—and sell it at auction. A secured creditor will have to wait until the bankruptcy is over or file a successful motion to lift the automatic stay.
The only exception is when the secured property has a significant amount of equity in it. For instance, assume that a home is worth $300,000. The balance owed is $75,000 and the debtor can exempt $25,000. In this case, the Chapter 7 trustee would sell the home, pay off the $75,000, thereby making the lender whole, give the debtor the $25,000 exemption amount, and use the remainder to pay unsecured creditors.
When you file for bankruptcy, you eliminate your obligation to pay the debt owed to the secured creditor. But you don't get to keep the collateral necessarily. Why? Because the lien will remain. Even though the creditor can't force you to pay, it can still foreclose or repossess the property. Here's how it works
You must indicate whether you plan to keep or surrender any property securing a claim, like your financed car, house, or any other property with a lien on it. When you surrender it, you give it back to the creditor.
If you're going to keep the property, you must continue making the creditor happy—in other words, by making regular payments on it. You'll do so either informally (some lenders will accept payments even after bankruptcy erases the contract) or after entering into a new contract, called a reaffirmation agreement.
Keep in mind that to keep secured property, you must also be able to protect all of the equity with a bankruptcy exemption. Otherwise, the Chapter 7 trustee will sell the property, pay off the loan, give you the exemption amount, and use any remaining portion (after sales costs) to pay unsecured creditors.
Learn how to redeem secured personal property in Chapter 7—an option that could reduce the amount you'd have to pay the creditor. Also, find out how to avoid certain liens in bankruptcy.
One of the hallmarks of Chapter 13 bankruptcy is that you can keep all of your property—including your secured property. But you'll need to do three things in your Chapter 13 repayment plan:
Also, the Chapter 13 features that help borrowers reduce the amount owed on secured debt include lien stripping and cramdown.
These types of debts aren't secured by collateral. Examples of unsecured debt include credit card balances, medical bills, personal loans, utility balances, gym memberships, and the like.
If you don't pay, the creditor can't recover the product or service you purchased. Instead, the creditor must first take you to court and prove how much is owed. A judgment creditor—one who has won a collection lawsuit—can use the judgment to garnish wages, levy bank accounts, and recover property.
Whether your debt will get wiped out—and whether a creditor will get paid—in large part will depend on if the debt is classified as a priority unsecured debt or a nonpriority unsecured debt.
Some obligations are more important than others, and therefore, must be paid. In bankruptcy, they receive special treatment and are known as "priority debts."
The most common types of priority claims include certain tax obligations, alimony, and child support. If money is available for payment in a Chapter 7 case, these debts must be paid in full before nonpriority unsecured claims receive a dime. Further, they aren't dischargeable, so you will remain on the hook for the unpaid priority balance after bankruptcy.
If you file for Chapter 13 bankruptcy, priority claims must be paid in full through your repayment plan. Because Chapter 13 plans can't be longer than five years, if you have a substantial amount of priority claims, your plan payment would need to be large enough to pay the entire balance within the plan period.
Most nonpriority unsecured claims get discharged in bankruptcy. Student loans are an exception. Although they're nonpriority unsecured claims, they aren't dischargeable unless you prove that it is unlikely you'll ever be able to pay them. In Chapter 7 bankruptcy, nonpriority unsecured creditors are the last to get paid when money is available. They each receive a pro-rata share of the pool of funds.
In Chapter 13 bankruptcy, the amount you pay general unsecured creditors depends on your nonexempt assets and disposable income. While they usually only receive pennies on the dollar, many filers—such as those with a lot of nonexempt property or a substantial income—pay significantly more.
Learn more about priority and nonpriority unsecured debt in bankruptcy.