All Debt is Not Created Equal

When filing for bankruptcy protection, not all debt is created equally. Regardless of whether you are filing under chapter 7 or chapter 13 of the bankruptcy code, whether a debt is secured or unsecured makes a huge difference in how that debt is treated by the bankruptcy court. In addition, whether or not a debt is secured determines how a debtor can collect on an unfulfilled debt. As a result, it is important that anyone facing default on a debt or considering bankruptcy protection understand this distinction.

What is an Unsecured Debt?

An unsecured debt is an obligation that is not attached to any specific property as collateral for partial or complete fulfillment of the debt in the case of default. Common examples of unsecured debts include medical bills, utility bills, many credit cards, and personal loans. Mortgages and automobile loans are common exceptions, as these are secured debts.

If you default on an unsecured debt, the creditor is generally unable to collect on that debt through means such as repossession as there is no property associated with the debt to repossess! Instead, they must file a lawsuit to obtain a court judgment. In the meantime, the creditor may resort to harassing tactics in an attempt to collect on the debt.

You will be served by a copy of any lawsuit filed by a creditor in an attempt to collect an unsecured debt. You have an opportunity to file a response to this claim to contest the validity of the debt or default. If you do not respond to the lawsuit, the court will likely side with your creditor and issue a default judgment.  This means your creditor can now collect on the unsecured debt.

Once a creditor has obtained a judgment against you, there are many ways in which they can collect on the unpaid debt. They commonly collect by garnishing your wages or placing a levy on your bank account. On notable exception occurs when you default on federal student loans or tax debt, as these government entities can attempt to collect on default without first obtaining a judgment. 

What is a Secured Debt?

Debts that are associated with a piece of collateral that your creditor can recover in cases of default are classified as secured debts. Two common examples of secured debts are home mortgages and vehicle loans. If you default on your automobile loan, your lender may repossess the vehicle. Similarly, if you default on your mortgage payment, your lender may start the process of foreclosure to recover the securing property.

When you sign a mortgage document or finance an automobile, you are agreeing that a lien will be placed against the securing property until the debt is paid in full. Another type of secured debt occurs when a lien is placed against real property in accordance with the law. This is referred to as an involuntary lien and, unfortunately, does not require your agreement. Examples of involuntary liens include liens for delinquent property or income taxes, landlord liens, judgment liens and mechanics liens. 

Why Does it Matter?

When considering bankruptcy, it is important to fully understand the nature of your debts, including whether they are secured or unsecured. This is because such debt types are handled differently based on this classification. Generally speaking, the successful discharge of a bankruptcy case will eliminate the personal liability associated with the debt, but not the security interest in the collateral property. This means that the creditor can take back the property even after bankruptcy eliminates the debt.

For many people, filing for bankruptcy under Chapter 7 of the bankruptcy code is prudent financial decision. Upon completion (“discharge”) of a Chapter 7 bankruptcy, most unsecured debts will be eliminate which provides the debtor with a financial fresh start. However, it is important that anyone considering filing for bankruptcy protection research the property exemptions provided by the district in which they are filing. This is because Chapter 7 bankruptcy allows for the sale (“liquidation”) of any unprotected assets by an assigned trustee. If you are not careful when filing for Chapter 7 bankruptcy, you risk losing your personal property.  You should consult an experienced Phoenix bankruptcy lawyer regarding the classification of your debt and how it will be treated in Chapter 7 and Chapter 13 bankruptcy.