Understanding the three classes of debt will help you figure out how bankruptcy works. Bankruptcy law does not play favorites with your creditors, except when those creditors are legally different. The most basic way that creditors are legally different is in their classification: secured or unsecured debt, and priority debt.
Secured Debts
With secured debts, the money you owe is secured by collateral. For example, types of collateral used for secure loans can include a home and/or home equity or your vehicle for a secured car loan. Your obligation to pay is backed up by a lien on one or more of your assets—your real estate or personal property—giving the creditor specific power over that property if you do not pay the debt.
The most common secured debts are vehicle loans and home mortgages, and contracts for furniture, appliances, or electronics. Also, a debt which was not secured can involuntarily turn into a secured debt. This can occur when a creditor files a lawsuit against you and gets a judgment lien against your home.
Secured debts are referred to most directly in Section 506 of the Bankruptcy Code.
General Unsecured Debts
An unsecured debt is simply one not backed up by a lien on collateral. The creditor has no right to anything that you own, unless that creditor first gets a judgment against you. “General” unsecured debts are distinguished from “priority” ones.
General unsecured debts include most credit card debt, medical bills, deficiency balances on repossessed vehicles or other collateral, many personal loans, and numerous other kinds of debts. It’s the “leftover” type of debts—if the debt is not secured (even if it once was) and doesn’t fit within the narrow set of “priority” debts, it’s a general unsecured debt.
Priority Debts
In the minority of consumer Chapter 7 cases where the bankruptcy trustee receives some of your assets for distribution to your creditors, Congress has determined that certain special categories of debts should be paid ahead of the general unsecured debts. It has also determined the order, or the “priority,” in which these special debts are to be paid. In a Chapter 13 case, all these priority debts have to be paid in full before your case can be completed.
That priority list, found at Section 507 of the Bankruptcy Code, includes the following most common types of consumer debts, in descending order of priority:
- child and spousal support (c)
- the administrative costs of the bankruptcy case (t)
- certain income taxes (c)
some other kinds of tax debt (s)
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Understanding the three classes of debt isn’t just vital for successfully filing for bankruptcy. This knowledge can help you for years to come when it comes to your personal finances and utilizing credit in a healthy way as you rebuild credit after a bankruptcy.
If you’d like to know more about any of the three debt classes, contact our Fort Worth and Dallas bankruptcy lawyers for a free case evaluation. Our tax relief attorneys can help improve your understanding of the three classes of debt.
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