Bankruptcy 101: The Difference Between Secured and Unsecured Debts
Few people want to make the choice to file for bankruptcy, but medical bills, job loss, and other unexpected financial problems can leave you with debt that seems impossible to whittle away, making bankruptcy a reasonable option. Bankruptcy is a way to erase the stress that comes from being unable to meet those financial obligations, allowing you to get your life back on track.
There are two different types of personal bankruptcy – Chapter 7 and Chapter 13. Chapter 13 bankruptcy is essentially a reorganization of debt, and requires those who file to pay back some of the debt owed to creditors by working out a repayment system. The amount paid back depends on income as well a property equity. Chapter 7, on the other hand, is designed to erase most of a person’s debt, allowing them to get a fresh financial start.
There are two different types of debt addressed in a Chapter 7 bankruptcy – secured debt and unsecured debt. Secured debts are treated differently in Chapter 7 bankruptcy than unsecured debt, although in most cases, those who file for bankruptcy are allowed to keep their home and vehicle as long as they have not defaulted on their payments.
What Is a Secured Debt?
Secured debts are debts such as a mortgage or a car loan, both of which use the property tied to the loan as collateral, which makes the debt secure. If you default on a secure loan, creditors can foreclose on your house or repossess your vehicle, making the loan less risky for those lenders.
Other types of secure debt include:
- Title loans, because the vehicle again serves as collateral for the loan.
- Furniture loans, because furniture can be repossessed by the company if you miss a loan payment.
- Rent-to-own purchases. The interest rates are high, making these loans difficult to pay back, but the property bought on loan can be repossessed if a payment is missed.
In most cases, if you are up-to-date on your mortgage, car or furniture payments, you can keep them if you file Chapter 7 bankruptcy, although the debt won’t be wiped out, and you can lose those assets if you become delinquent.
What Is an Unsecured Debt?
On the other hand, unsecured debt such as credit cards debts are riskier for the lender, because there is nothing used as collateral that allows them to recoup any of their funds if the borrower defaults on a loan. Because of that, the interest rates on unsecured loans are often much higher, so that if a person eventually defaults on the loan, the lender is less likely to lose much money.
In addition to credit cards, other examples of unsecured debt include:
- Student loans.
- Payday loans.
- Medical bills.
- Court-ordered child support.
When filing Chapter 7 bankruptcy, much of your unsecured debt can usually be erased, including – in some cases – student loans, although it is widely believed that they cannot be included in a bankruptcy filing. In 40% of all Chapter 7 bankruptcies, judges have discharged all or at least a portion of some student loan debt, depending on the results of the Brunner test, established in the 1980s. The three-part test requires debtors to prove that they cannot maintain a minimal standard of living if forced to repay their student loans, must show that their financial circumstances are unlikely to change based career choice, for example, and must prove that they have attempted to repay their loans despite the hardship. Private student loans, however, are rarely discharged through bankruptcy.
Other unsecured debt that cannot be discharged through Chapter 7 bankruptcy includes court-ordered child support, alimony and spousal support, most tax debt, debt incurred as a result of fraud (such as lying on an application for credit) or debt incurred for luxuries, such as a 7-day cruise to the Bahamas you paid for with a credit card.
Getting Help with Chapter 7
For more information about filing Chapter 7 bankruptcy or to learn more about secure and unsecured debt, contact Maxwell Dunn. We can walk you through your options and help you decide what your next steps should be. Contact our team today.See all videos