When you file for bankruptcy, the bankruptcy court will typically divide your debt into two categories, secured debt and unsecured debt. Each of these debts are treated differently – and understanding their differences is necessary to knowing what will happen to your debts and how your finances will be affected during a bankruptcy.
What is Secured Debt?
A secured debt is a loan that is secured by an item or a property which serves as a guarantee that you will repay your debt based on the terms and conditions you and your creditors have agreed upon. This collateral can be a house, car, or any high-valued item. In the event that the debt is not repaid, your creditor can seize the collateral as a way for them to recoup their loss from the debt you owe.
The common examples of secured debt include a mortgage or house loan, title loan and auto loan.
What is Unsecured Debt?
With unsecured debts, the debt is not tied to an asset or collateral. Your creditors cannot seize your property in the event you default on your debt. As a result, your creditors may need to find another way to force you to pay back the debt. They may file a lawsuit against you, ask for a court petition to garnish your wages, or hire a debt collector.
The common types of unsecured debt are student loans, credit card debt, medical bills debt and personal loans.
What Happens to Each type of Debt When You File for Bankruptcy?
As stated above, each type of debt will be treated separately from each other should you file for bankruptcy. Your debts will also be treated differently depending on the type of bankruptcy you are filing for.
Bankruptcy is subdivided into two categories, Chapter 7 and Chapter 13. Chapter 7, also called liquidation, allows you to eliminate most of your debts and gives you the chance to have a clean slate again. However, one of its drawbacks is that your property can be seized in lieu of the amount owed.
On the other hand, a Chapter 13 requires you to commit to a debt repayment plan designed to help you manage debt payment for a period of 3 to 5 years. In Chapter 13, you are able to keep your assets as long as you are able to comply with the agreed upon repayment plan.
When you have a secured debt and you file for Chapter 7, your liability to pay it is going to be discharged. However, your creditors can still seize your assets. To ensure you keep your assets, you can opt to continue making payments. When you file for Chapter 13, you will avoid foreclosure as creditors will not be allowed to take your property as long as you comply with the agreed upon monthly payment plan.
Meanwhile, if you have unsecured debt, filing Chapter 7 will wipe out most of your unsecured debts. When you file for Chapter 13, your unsecured debt will become part of the debt repayment plan, but the law won’t require that the unsecured debt be paid in full. So, when the repayment plan is over, the remaining debt will also be discharged.
Paying off your debt can sometimes seem like a tall order. When you’ve exhausted all your efforts to resolve your debt without making much progress, filing for bankruptcy may be your last resort.