Understanding Secured vs. Unsecured Debt

In a Chapter 7 or Chapter 13 bankruptcy case, one debt is like any other debt, correct? Most people assume that when they owe money to a creditor, you list that creditor in your bankruptcy schedules, and the debt goes away.

This assumption is a bit simplified because certain debts are treated differently from other debts in a bankruptcy case. Secured creditors and priority unsecured creditors receive special treatment because of the type of debt owed to the creditor. To understand how the Bankruptcy Code treats creditors, we first need to understand secured and unsecured debt.

Unsecured vs Secured Debt

Secured and unsecured debt is treated differently in bankruptcy. It is important to define debts correctly when filing a bankruptcy petition because the bankruptcy priority determines the order of payment in a bankruptcy case.

Unsecured Debt Definition

An unsecured debt is not secured by collateral. Therefore, we refer to the creditor as an unsecured creditor. Examples of unsecured debts include credit cards, medical expenses, utility bills, most taxes, and personal loans.

Secured Debt Definition

A secured debt is guaranteed by collateral. Secured creditors hold a lien on the collateral, such as a home or a vehicle, to guarantee payment of the debt. If the debt is not paid, a secured creditor can repossess or foreclose to obtain the collateral.

How Is Order of Payment Determined?

The priority of claims determines who receives payment first in a bankruptcy case. Having a secured claim does not always guarantee the creditor will receive payment first or at all through a bankruptcy. To establish the order of payment, the bankruptcy trustee must review each claim filed with the bankruptcy court to determine the type of debt and the status of the claim.

How Do You Define Secured Debt?

As discussed above, a secured creditor holds a lien on collateral. In a Chapter 7 case, you must continue to pay the payments to a secured creditor if you want to keep the property.

If you do not want the property or you do not want to continue making payments on the debt, you can surrender the property in full satisfaction of the debt. Your bankruptcy discharge prevents the creditor from attempting to collect any remaining balance on the account.

However, in a Chapter 13 case, secured claims can be handled in different ways. For example, you can surrender the property as you would in a Chapter 7 case to get rid of the debt. If you want to keep the property, you must continue making the payments within the bankruptcy plan or outside the plan. Most car loan payments are paid through the bankruptcy plan while most mortgage payments continue outside the plan.

One benefit of Chapter 13 is that you may be able to lower the amount you owe for the lien on your car by filing a motion to value. If your vehicle is worth less than you owe on the loan and the debt meets certain criteria, you could pay much less to satisfy the lien through a Chapter 13. You may also reduce the interest rate owed on the secured debt.

Another benefit of Chapter 13 is you may value a second mortgage in some cases. If your home is worth less than you owe on a first mortgage, you might be able to value the second mortgage at zero. If the court approves the motion to value, the amount owed on the second mortgage becomes an unsecured debt that is discharged when you complete your Chapter 13 plan.

How Do You Define Unsecured Debt?

An unsecured debt is a debt that is not guaranteed by collateral. An unsecured creditor does not hold a lien on property that it can foreclose or repossess. In a Chapter 7 case, most unsecured debts are discharged at the end of the case.  A creditor with a discharged debt may not take any further action to collect the debt, including filing a lawsuit, sending collection letters, or seizing property.

Unsecured debts fall into one of two categories:

General Unsecured Debts

Creditors with general unsecured claims do not have priority. In Chapter 13 cases, these debts are often completely erased and any that are paid back (depending on income) often receive pennies on the dollar. In a Chapter 7 case, most general unsecured debts are discharged (erased) at the close of the case. Student loans and child support are exceptions. Student loans cannot be discharged in bankruptcy except in rare cases in which the debt owed meets a narrowly defined set of parameters. Child support is never eligible for a discharge.

Priority Unsecured Debts

Creditors with priority unsecured claims are treated differently from general unsecured creditors. Examples of bankruptcy priority claims include most taxes, alimony, child support, restitution, and administrative claims. In a Chapter 7 asset case, priority claims receive payment in full before any payments to general unsecured creditors. Priority debts are nondischargeable. If there are no funds to pay the debts, you continue to owe the priority debt after your case closes.

In a Chapter 13 bankruptcy plan, priority creditors receive payment in full before payments to general unsecured creditors. As in a Chapter 7 case, priority claims are nondischargeable in a Chapter 13 case.

Get Help from a Dallas Bankruptcy Lawyer

Distinguishing between secured vs unsecured creditors can be difficult. However, it is crucial to correctly identify debts for the bankruptcy order of payment to be correct. Because it is important in a Chapter 7 or Chapter 13 bankruptcy who gets paid first, you need an experienced Dallas or Fort Worth bankruptcy lawyer to assist you in preparing your bankruptcy schedules.

Contact Leinart Law Firm by calling (469) 232-3328 or (817) 426-3328 for a free consultation with a Texas bankruptcy lawyer.