Author’s note by Attorney Howard Iken: This article provides information about the differences between secured and unsecured debt in the context of bankruptcy, particularly in Florida. It explains that secured debt is backed by collateral, such as a home or automobile, which can be repossessed if the debtor fails to make loan payments. Secured debt can be voluntary (e.g., car loan, mortgage) or involuntary (e.g., property taxes). On the other hand, unsecured debt is not backed by collateral and includes debts like credit cards, medical bills, and student loans. The article mentions that in Chapter 7 bankruptcy, most unsecured debts can be discharged, except for certain obligations like student loans, child support arrears, and recent tax debts. It also discusses options for handling secured debt in Chapter 7 bankruptcy, such as surrendering the property, reaffirming the debt, or redeeming the property. Additionally, it briefly mentions Chapter 13 bankruptcy, where the repayment plan determines the amount paid to unsecured creditors based on disposable income and means testing.
Introduction
If you are considering filing for Florida bankruptcy, you may be unsure of the differences between secured and unsecured debt. It is important for you to fully understand the differences before you file for bankruptcy. In fact, there is a big difference in how your debt will be treated according to whether it is secured or unsecured. This is true whether you are filing for Chapter 7 bankruptcy or Chapter 13 bankruptcy. Even if you have not yet decided to file for bankruptcy, the way a creditor can collect your debt is determined by whether it is secured or unsecured.
What is Secured Debt?
The short definition of a secured debt is an obligation you owe that is backed by collateral—an item such as a home or an automobile—which a creditor can recover if you fail to make your loan payments. Secured debt can be either voluntary or involuntary. As an example, when you choose to take out a car loan or a mortgage, you have entered into a voluntary secured debt. The property taxes attached to your home, however, are involuntary debts or liens. Almost without exception, if you are making regular payments on any type of real property, you are agreeing the property will serve as collateral for the debt. If you stop making payments, the lender has the option of repossessing the property. After foreclosure or repossession, the property or the automobile can be sold, and if there is a difference between the amount you owe and what the car or property sold for, the lender can obtain a deficiency judgment against you for the difference.
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The “Parts” of a Secured Loan
There are, essentially, two parts to a secured loan. You, as the borrower, have personal liability for the loan and are obligated to pay the debt. If you file for Chapter 7 bankruptcy and the debt falls under “dischargeable,” then your personal liability has been wiped out, and you cannot be sued in order to collect the unpaid balance. The second part of a secured loan is your lender’s legal claim on the property you put up as collateral for the loan. The legal claim (also known as the lien or the security interest) allows your lender to repossess or foreclose on the automobile or property if you do not pay the debt. These liens are not affected by a bankruptcy discharge—if you fail to stay current on your mortgage or auto loan, then despite filing for bankruptcy, you can still lose the property or automobile, even if the debt itself is discharged.
Chapter 7 Options if You are Current on Your Home or Auto Payments
If you are current on your mortgage and/or auto loan, you will have the following options when you file for a Florida Chapter 7 bankruptcy. First, you can surrender your property—walk away from the debt free and clear, with no foreclosure or repossession. Second, if your equity in your home is protected by an applicable exemption under Florida bankruptcy laws, you can reaffirm your debt and retain your property. The third option is to keep your property through the redemption process—if your equity is protected under an applicable Florida bankruptcy exemption. The first option—surrendering your property—is fairly self-explanatory. You will no longer have your home or automobile, but you will not have a foreclosure or repossession on your record in addition to a bankruptcy.
Reaffirmation—Should You Choose This Option?
The second option—reaffirmation—sounds fairly straightforward but is actually a bit more complex. When you reaffirm a debt, such as your mortgage or auto loan, you are agreeing you will still owe the debt after your bankruptcy case is over and done with. Your lender’s lien on your property, as well as your personal liability for the debt, remain as though you had never filed for bankruptcy. Whatever you owed prior to filing for bankruptcy, you will still owe. If, after filing for bankruptcy, you are unable to make your mortgage or auto payments, you will have the property foreclosed or your automobile repossessed, and your property will be sold at auction.
The positive side to reaffirmation is that you can still live in your home and drive your car. The disadvantages to reaffirmation are that you remain legally bound to pay the remainder of the loan, and cannot file for Chapter 7 bankruptcy for another 8 years, so you must keep your payments current. While reaffirmation can be used with any type of lien, the lender must agree to the terms for the reaffirmation if they are different from your current agreement. If you wish to reaffirm your mortgage or auto loan, make sure you keep current on your payments.
Choosing the Redemption Option
Under Chapter 7 bankruptcy, redeeming your property means you buy it back from your lender in one lump sum for “replacement value.” Replacement value is the price the property would be worth, taking into consideration the age and condition of the property. In some instances, the replacement value could be less than what you currently owe. If your lender is not in agreement regarding replacement value, a valuation hearing could be held.
Under Chapter 7 bankruptcy, you can only redeem tangible, personal property which is a consumer debt on goods used for personal or household purposes and is exempt (or abandoned by the trustee because it has little or no equity). If the amount you owe is significantly higher than the property’s value, the advantage to redemption is the lender must accept the replacement value. The disadvantage is, of course, finding the money to repurchase the property.
Chapter 7 Options if You are NOT Current on Your Home or Auto Payments
If you are not current on your home or auto loan, (your secured creditor), Chapter 7 bankruptcy will not prevent repossession or foreclosure, even though you are given certain exemptions for your home equity and auto equity. If you are behind on payments, your lender can ask the court to lift the automatic stay, allowing them to proceed with repossession. If you want to keep the property, you will have to make up the missed payments and fees associated with default, then resume regular payments. If the loan has been accelerated, you can file for Chapter 13 bankruptcy, which allows you to make up the missed payments—as long as you also continue making the regular payments at the same time.
What is Unsecured Debt?
As opposed to secured debt, which is backed by a tangible piece of property, unsecured debts are not secured by the property. This means if you stop paying on the loan, your lender or creditor cannot take anything from you until a judgment has been obtained against you through the court process. Student loans are unsecured debt, as are credit cards, health club membership fees, medical bills, rent and utility payments and attorney’s fees. Having said that credit cards are unsecured debt, there are exceptions. If you signed a security agreement when you applied for the card, it could be considered secured debt, so be aware of this fact when applying for credit cards.
If you are filing for Florida Chapter 7 bankruptcy, most of your unsecured debt will likely be wiped out. There are exceptions, however. While student loans are unsecured debt, they are generally not dischargeable under bankruptcy. Child support arrears and spousal support arrears are also not wiped out during Chapter 7 bankruptcy, despite the fact they are considered unsecured debt. Many people are under the mistaken belief they can wipe out crushing student loan debt by filing bankruptcy, however, this is simply not true. Any unpaid tax debts which first became due within the prior three years before filing bankruptcy are also not dischargeable under Chapter 7 bankruptcy laws.
So will your unsecured creditors receive any of the money you owe them if you file for Chapter 7 bankruptcy? Your trustee will take your nonexempt property, sell it and distribute the proceeds to your unsecured creditors. If your property was the security for a specific debt, that creditor will be paid first. As an example, if you have a non-exempt automobile which is worth $11,000, the trustee will sell the automobile, pay the $6,000 you still owed on the vehicle, and the remaining $5,000 will be distributed among all of your unsecured creditors, in order of priority.
Priority debts such as child support, alimony, and tax debts will be paid first. If, after the secured debt and the priority debts are paid, there is any money left over, your other unsecured creditors—such as credit card companies—will be paid.
Under Chapter 13 bankruptcy, the amount you will pay to your unsecured creditors will depend on your level of non-exempt assets and disposable income, however, it is likely they will receive pennies on the dollar.
Priority Claims for Non-dischargeable Unsecured Debt
There are specific claims under bankruptcy laws that take priority, meaning they receive special treatment. The most common types of priority claims are specific tax obligations, child support and alimony. These debts, under Chapter 7 bankruptcy, are paid prior to paying general unsecured claims; because they are non-dischargeable, you must still make the payments during and after bankruptcy. Under Chapter 13 bankruptcy, these priority claims must be paid in full under your specific repayment plan. A Chapter 13 repayment plan is generally from three to five years (no longer than five years). This means these priority claims must be paid in full within the allotted time period.
Unsecured Debt under Chapter 13 Bankruptcy
When you file for Chapter 13 bankruptcy, while you will pay 100 percent of your secured and priority debts (with some exceptions), how much you will pay on your unsecured debts depends on the following factors:
- Under Chapter 13 rules, all of your disposable income must go toward making regular monthly payments under your repayment plan. This means the amount your unsecured creditors will receive will depend on the amount of money you have left over each month after you have paid your normal living expenses, your secured debt payments, and your priority claims.
- At a bare minimum, your unsecured creditors must receive at least as much as they would have received if you had filed for Chapter 7 bankruptcy.
Your Chapter 13 repayment plan must show your best effort at paying back non-priority, unsecured creditors. You will provide your average monthly income for the six-month period prior to the time you filed for bankruptcy when you complete the Chapter 13 means test. How much you will pay your unsecured creditors will depend on whether your income is above or below the Florida state median income. If you are below the median income for the state of Florida, the court will assume you have no disposable income, therefore you will pay little—or nothing—to your unsecured creditors. If your income is higher than the Florida state median income, you will be required to complete the entire means test. You will be allowed deductions for specific expenses such as your mortgage and car payment. The amount, after your allowable deductions, will be multiplied by 60 in order to determine how much your unsecured creditors will receive.
How a Ayo and Iken Bankruptcy Attorney Can Help You
If you need more information regarding whether specific debts you owe are unsecured or secured, as well as how they will be treated during your Florida bankruptcy proceedings, it is important to speak with a knowledgeable Ayo and Iken bankruptcy attorney who can not only answer your questions but who can protect your rights and your future during this difficult time.