An important distinction between the types of credit one can obtain is that of secured and unsecured. The difference is straightforward, but very significant, especially if you file a bankruptcy.
The Security Interest
Many loans carry what is known as a security interest with them. The mortgage loan and a car loan are perhaps the most common type. As with many financial instruments, they are made up of more than one document. There is the mortgage, which contains the terms of your loan, such as amount and repayment schedule, which may be known as the promissory note (your promise to repay).
The second part of the instrument is the security interest, which describes the property that provides security or collateral for the promissory note. This is what allows a financial institution to repossess your home or car when you fail to make the required payments on the debt.
Unsecured Debt
Another type of popular debt is an unsecured loan. A well-known example of this is a credit card. Your card issuer provides you with a credit limit and you can buy virtually anything up to that limit. Your payments vary depending on how much a balance you carry. This allows the credit card company to earn interest and fees on your account.
What they don’t receive is a security interest in anything you have purchased with the credit card. They cannot reclaim the dinner you purchased, the movie you saw or the vacation you took.
Student loans are another significant area of unsecured loans, recently having surpassed credit card debt in total amount. However, the treatment of these two unsecured debts in a bankruptcy is very different.
Unsecured Debt in Bankruptcy
Because most Chapter 7 bankruptcies are filed as “no asset,” meaning the debtor has no assets that can be sold to reimburse creditors; we will focus on Chapter 13.
In a Chapter 13, secured assets have to be surrendered or paid for, through the Chapter 13 plan. Unsecured assets are to be repaid with any remaining disposable income after accounting for all the secured assets and necessary expenses.
This means that in a Chapter 13 bankruptcy, unsecured creditors may only receive a portion of their debt. This can be very helpful for a debtor who wants to stay in their home, but because they have lost a job or income, may be having difficulty paying all their bills.
If you have a significant amount of unsecured debt, a Chapter 13 may allow you to discharge much of your unsecured debt and focus your income on repaying your mortgage and car loans.
Except when that debt is student loan debt, and in that case, you can only discharge that debt in a bankruptcy if you qualify for extreme hardship discharge.
Bankruptcy’s treatment of the various types of debt can be confusing and is full of exceptions. If you are considering filing bankruptcy, contact an experienced bankruptcy attorney who can advise you on how bankruptcy will treat your particular debt situation.
