Debts secured by liens on your property or possessions often grab the most attention during a bankruptcy case.
“General unsecured” debts, discussed in my last two blog posts, are handled in a relatively straightforward fashion in bankruptcy. In a Chapter 7 case, they are generally discharged (legally written off) without any opposition by the creditors. Those creditors usually get nothing. And in a Chapter 13 case, “general unsecured” debts often are paid simply whatever money is left over, if any, after the secured and priority debts and the trustee and attorney fees are paid. There’s because the creditors usually don’t have much to fight about.
But with secured debts—debts secured by collateral or through some type of lien—your property or possessions that are providing security are often a point of contention.
The next few blog posts will be about how to use Chapter 7 or Chapter 13 to deal with the main kinds of secured debts. Today I start with some important points that apply to most secured debts.
Two Agreements in One
A secured debt effectively involves two interrelated agreements between you and the creditor. First, the creditor agreed to give you money or credit in return for your promise to repay it on certain terms. Second, you gave the creditor certain rights to the collateral, including the ability to take that collateral from you if you don’t comply with the terms of your promise to repay the money.
Generally, bankruptcy will only undo that first agreement—your promise to pay. In contrast, your creditors’ rights to collateral generally survive bankruptcy.
The Value of Collateral
How much the collateral is worth as compared to the amount of the debt becomes very important as to what happens to that collateral.
If the collateral is worth a lot more than the amount of the debt, this debt is considered well-secured. Then there’s a much better chance that the debt would be paid in full. You’ll really want to pay off the relatively small debt to get the relatively expensive collateral free and clear of that debt. Or if you didn’t make the payments the creditor will get the collateral and sell it for at least as much as the debt.
If the collateral is worth less than the amount of the debt, the debt is considered undersecured. It’s less likely that such a debt would be paid in full because in return you’d get collateral worth less than what you’re paying.
Depreciation of Collateral, and Interest
Since the value of the collateral is such an important consideration for a secured creditor to be made whole, the loss of its value through depreciation is something that creditors care about, and about which the bankruptcy court respects.
Also, in most situations secured creditors are entitled to interest. So, you’ll see in our next blog posts that when there are conflicts with secured creditors—on home mortgages or vehicle loans, for example—issues about depreciation and interest become important.
Virtually every agreement with a secured creditor—definitely those involving vehicles and homes—requires that you carry insurance on the collateral. If the collateral is damaged or destroyed, this insurance usually pays the debt on the collateral before it pays you anything. And, if you don’t get the required insurance, the creditor itself can buy insurance to protect only its interest in the collateral AND charge you for it.
With these points in mind, the next blog post will tell you your options with your vehicle loan under Chapter 7.