What is Secured Debt in Bankruptcy?

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In a Nutshell

When you get a loan by promising property as collateral to a creditor, you have a secured debt. A Chapter 7 bankruptcy can eliminate your obligation to pay a secured debt. But, bankruptcy can’t prevent creditors from taking any property you pledged if you default on your payments.

Written by Attorney Jonathan Petts.  
Updated July 22, 2020

When you get a loan by promising property as collateral to a creditor, you have a secured debt. A Chapter 7 bankruptcy can eliminate your obligation to pay a secured debt. But, bankruptcy can’t prevent creditors from taking any property you pledged if you default on your payments. This article explains secured debt and what happens to it in bankruptcy.

What is secured debt?

There are two types of debt: secured and unsecured. A secured debt gives the creditor a security interest in some piece of property, like a house or a car. An example of secured debt would be a mortgage or a car loan. An unsecured debt, like the name suggests, does not give the creditor any rights to your property. An example of unsecured debt would be a credit card or personal loan.

A creditor with a security interest is called a secured creditor. They have the right to repossess or force a sale of the property used to secure the debt in the event of default. The secured creditor will generally use the money they get from selling the property to satisfy the remaining balance on the loan.

If the value of the property is not enough to pay back the rest of the loan, a secured creditor can also sue in order to recover the remaining balance (called the deficiency balance). Your obligation to pay the deficiency balance can be discharged in a successful Chapter 7 bankruptcy.

How do I know if I have secured debt?

If you have a car loan or a mortgage, it is likely that you have secured debt. Generally, any loan which is received in connection with a property purchase will be secured by that property. The best way to determine whether a debt is secured debt is to check the loan agreement.

Secured Debt Example

Sally gets a loan from the bank for $10,000 to purchase a car. The loan is a secured debt, because it gives the bank the right to repossess Sally’s car if she defaults on her loan payments. A few years later, Sally still has a $7,500 balance on the loan, but her car is only worth $5,000.

If Sally fails to make payments on the secured debt, the bank can repossess and sell her car to meet the loan obligation. Because the loan balance even after the car sale is $2,500, the bank can sue Sally to collect that amount.

If Sally successfully discharges her debts in bankruptcy, she no longer has to pay the $7,500 balance on her loan. But, the bank can still repossess her car. Even if selling the car does not pay off the debt, Sally would not have to pay the remaining $2,500 balance — it would also be discharged.

What happens to secured debt in bankruptcy?

In a Chapter 7 bankruptcy, your assets are sold in order to pay your debts to creditors. Exactly how this happens, and in which order creditors are paid, will depend on your unique circumstances. However, there are a few options generally available for dealing with secured debt, depending on whether you want and are able to keep the property pledged as collateral.

Options to keep property used to secure a debt in bankruptcy

In order to keep property used as collateral for a secured debt, you have the option of paying the creditor the total amount of its secured claim (minus any exemptions), redeeming the property by paying its actual value, or reaffirming the debt and continuing to make payments.

If you opt to pay the creditor, the money you use must come from your equity or non-estate sources.

Sometimes, the property used to secure the debt will be worth less than the remaining loan balance on that debt. In that case, your best option could be to try and redeem the property by paying the creditor the actual value of the property. For example, if the balance on your car loan (a secured debt) is $7,500, but your car is only worth $5,000, it would be cheaper to redeem than to pay off the car loan. However, not all property can be redeemed, and any redemption must be approved by the court.

Because of the difficulty in having a large lump sum available to pay a loan balance or redeem property, you can instead try to reaffirm the secured debt. When you reaffirm a debt, it is removed from your Chapter 7 estate and you must continue making payments on that debt to the lender. The lender must agree to any reaffirmation, and you will have to submit a new written agreement to the court. Generally, any reaffirmation of a secured debt will have the same payment terms as the original agreement.

Surrendering property used to secure a debt in bankruptcy

If it is not feasible for you to continue making payments on a secured debt, the secured creditor may seek to repossess the collateral for that debt. Giving up the collateral that secures a debt as part of a successful bankruptcy eliminates your obligation to make any more payments on that secured debt. The downside is that you will lose your property.

A secured creditor will not always try to repossess collateral. They may not think it is worthwhile to go through the effort of repossession and sale. This is especially true in situations where it is unclear if the creditor has a legitimate security interest in the collateral.

Listing secured property in a Statement of Intentions

When you file for Chapter 7, you must complete a Statement of Intentions which lists your secured debt and how you intend to treat it during the bankruptcy. The Statement of Intentions lets the court know whether you plan to surrender or retain your property. The Statement of Intentions must be filed within 30 days of filing your bankruptcy petition or by the date set for your meeting of creditors — whichever is earlier.

Conclusion: Secured Debt in Bankruptcy

Chapter 7 bankruptcy treats unsecured and secured debts differently. While bankruptcy erases your obligations to pay both types of debt, it does not eliminate a secured creditor’s right to seize your property that has been used as collateral. It is important to come up with a plan for how you want to handle secured debt in bankruptcy.

If you want to keep property used as collateral for a secured debt, you have options like paying the creditor the full remaining loan balance, redeeming the property by paying the creditor the actual value of the property (subject to court approval), or reaffirming the debt and continuing to make timely payments (also subject to court approval).

If you are willing to lose the property used as collateral for a secured debt, the creditor will seize the property. A successful bankruptcy discharge will eliminate your obligation to continue paying your secured debt, even if the collateral is not enough to fully repay your loan balance.

We understand that how debt is categorized and treated in bankruptcy can be confusing. See if you qualify for assistance from Upsolve, a non-profit that helps low-income Americans erase their debt with Chapter 7 bankruptcy at no cost.

About the author
Attorney Jonathan Petts

Jonathan Petts has over 10 years of experience in bankruptcy and is co-founder and Board Chair of Upsolve. Attorney Petts has an LLM in Bankruptcy from St. John's University, clerked for two federal bankruptcy judges, and worked at two top New York City law firms specializing in... read more

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