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Unsecured Credit Debt

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In a Nutshell

This article will help you understand what unsecured debt is, and how bankruptcy might be able to help you eliminate various unsecured debts. It will also discuss managing student loans, a type of debt that isn’t secured, but also usually isn’t dischargeable in bankruptcy.

Written by Attorney Amelia Niemi.  
Updated August 26, 2020


If you feel like you’re drowning in an ocean of debt, even making heads or tails of what type of debt you have can feel like a massive chore. Understanding your debt will help you figure out your best options. 

This article will help you understand what unsecured debt is, and how bankruptcy might be able to help you eliminate various unsecured debts. It will also discuss managing student loans, a type of debt that isn’t secured, but also usually isn’t dischargeable in bankruptcy. 

Understanding Unsecured Debt

Unsecured debt is not attached to any property. Examples of this type of debt include unsecured credit cards, medical bills, student loans, and personal loans from friends and family. Unsecured debt is different from secured debt, which is a loan that’s guaranteed by property, such as an auto loan that is secured by your car, or mortgage or home line of credit that’s secured by your house or other real estate. Similarly, secured credit card debt is secured by a deposit that generally matches the credit limit of the card. If you default on the credit card payment, you lose the deposit. If you default on a secured loan, the company you owe can take away the secured property. For real estate loans, this process is known as foreclosure. For car loans, this process is known as repossession.

Having too many unsecured loans can negatively affect your credit history and credit rating, which are measures of your creditworthiness. A lower credit score can make it harder for you to get good interest rates on future loans and credit lines.

Judgments Can Turn Unsecured Debt Into Secured Debt

It’s important to understand that unsecured debt can turn into secured debt. If a creditor is able to get a judgment against you for non-payment of your loans, including penalty payments and interest, this judgment can turn into a lien on your home, car, or bank account. In addition to negatively affecting your credit score, a lien can make it more difficult to sell your property.

If you can, you should avoid having a judgment entered against you. You can try to work towards negotiating a debt settlement arrangement with your creditors, which you might be able to do with your local court.

It’s also possible to voluntarily turn your unsecured debt into secured debt through specific forms of debt consolidation. Homeowners can take out a credit line tied to the equity in their home in order to pay off debts with higher interest rates. Using property to secure a new credit line lets people pay back debts at a lower interest rate, saving money in the long term. Even if you don’t own a home, your bank or credit union might extend you a credit line at a lower interest rate than what you’re paying your credit card company. This can be more effective than a balance transfer to a new credit card, which might only offer a lower interest rate for a short period of time.

Unsecured Debt in Bankruptcy

Bankruptcy divides unsecured debt into priority and nonpriority debts. Priority, unsecured debts include back taxes, child support, and spousal support (alimony). In all bankruptcy cases, these are paid first and in full, whenever possible. 

Finally, nonpriority, unsecured creditors receive funds that are left over after the rest of the creditors are paid. Common types of non-priority debts include student loans, credit card bills, utility bills, and medical debt. Both Chapter 7 and Chapter 13 bankruptcy provide debt relief for unsecured loans. However, the method of debt relief varies depending on the chapter being filed.

Unsecured Debt in Chapter 7

In Chapter 7, your non-exempt assets may be sold by the trustee assigned to your case. The proceeds from the sale are then used to pay your creditors in order of priority. Most people who file for Chapter 7 don’t actually have enough non-exempt assets to justify a sale, since a significant amount of property is protected by bankruptcy exemptions and excluded from the bankruptcy estate. Eligible unsecured debt is discharged at the conclusion of a Chapter 7 bankruptcy case. This means that you will no longer owe your unsecured creditors the remainder of your balance. Many people use Chapter 7 to discharge their medical debt, unsecured credit cards, and payday loans.

Unsecured Debt in Chapter 13

Chapter 13 operates a little differently than Chapter 7 does. Instead of having your non-exempt property sold to repay your creditors, your debts are paid down (and sometimes even off) in monthly payments over 3 or 5 years. As with Chapter 7, priority loans are paid in full first, followed by secured loans if you want to keep the property. 

Money left over at the end of the month is divided among your unsecured creditors. Each creditor receives a pro rata share of this money, based on how much you owe them as a percentage of your total unsecured loan debt. At the end of the Chapter 13 plan, unpaid unsecured, nonpriority debt is discharged, meaning that you won’t owe these debts anymore.

While these loans are being paid off as part of the repayment plan, Chapter 13 prevents creditors from charging high interest rates or taking other debt collection actions. Wages can’t be garnished, and debt collection companies can’t contact you about the loans. These rules give people who file bankruptcy some breathing room while they get their personal finances in order.

Student Loans in Bankruptcy

Even though student loan payments are nonpriority and unsecured, it’s really difficult to discharge them in bankruptcy. The general rule is that student loans can only be discharged in extreme cases of hardship. Even if you file for bankruptcy, it’s likely that you’ll need to pay your student loans in full over time.

While student loans can’t be discharged, they need to be included in your bankruptcy petition so the bankruptcy trustee can see what you owe. In a Chapter 13 case, a portion of your student loans can be paid as part of your monthly payments over the course of your plan, which will lower your overall balance. 

You do have other debt management options available to you when it comes to student loans. For example, a debt consolidation loan might be able to help you get rid of higher interest rates, making it easier to pay off your debt. You might also be able to work towards a debt settlement compromise with your student loan servicer. Additionally, if you either eliminate debts with a Chapter 7 filing or make payments more manageable with a Chapter 13 filing, you’ll be in a better position to make your student loan payments in a timely fashion.

Conclusion

Being weighed down by a large amount of debt can be exhausting. Filing for bankruptcy might be able to help you manage your debt and provide some financial freedom. If you feel like you’re drowning in unsecured debt, check out Upsolve’s free web app to see if it’s right for you. If you don’t think bankruptcy is the right answer for you, you can also explore other options for managing your debts, including debt settlement programs, on our website.



Written By:

Attorney Amelia Niemi

LinkedIn

Amelia Niemi is an attorney licensed in Illinois. She received her J.D. from DePaul University College of Law. At DePaul, she was a staff writer for the DePaul Journal of Art, Technology & Intellectual Property Law. Her legal practice includes multi-million-dollar international b... read more about Attorney Amelia Niemi

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