In this article, we will discuss the difference between secured debt and unsecured debt in Illinois bankruptcy cases and answer the following questions:
- What is secured debt?
- What is unsecured debt?
- What is priority debt?
- How is secured debt and unsecured debt handled in Chapter 7 bankruptcy?
- How is secured debt and unsecured debt handled in Chapter 13 bankruptcy?
When considering bankruptcy, the first question that must be answered is, “What type of bankruptcy is right for my situation?” For most people, the means test will determine their eligibility for Chapter 7 or Chapter 13 bankruptcy. Regardless of the style of bankruptcy you and your attorney decide is best, what happens to each of your debts, including whether they are paid, wiped out, or continue to be obligations after your discharge, depends on their status as secured, unsecured, priority debts.
What Is Secured Debt?
A secured debt is one that is secured by an asset. A common example of secured debt is the mortgage that is secured by your home. Secured debt allows the entity that secured the loan, usually a bank, to sell or repossess the property if you default on your loan. Another example of secured debt is a car loan. Your mortgage and car loan are both types of voluntary secured debt agreements (you signed the paperwork, so you agreed to the secured debt). There are some types of involuntary secured debt, such as the IRS placing a tax lien on your home.
What Is Unsecured Debt?
Unlike secured debt, unsecured debt has no collateral that can legally be sold or repossessed in the event that you are unable to pay. Examples of unsecured debts include credit card debt, medical bills, or lawsuit judgments. Unsecured creditors must file a lawsuit in court — and win — before they can begin collection proceedings on any unpaid debt. However, some unsecured debts must still be paid in full and can’t be discharged under bankruptcy, such as child support.
What Is Priority Debt?
Priority debts are a category of debt that must be paid off before all other types of debt. Priority debts include child support, most tax debts, spousal support, and the administrative costs of your Chapter 13 bankruptcy case (this includes your attorney’s fee and the bankruptcy trustee’s fee). A Chapter 13 bankruptcy plan must include payment of these debts or it will not be approved. Most priority debts will not be discharged under Chapter 7 bankruptcy and must be paid in full before any other type of debt.
How Is Secured Debt And Unsecured Debt Handled In Chapter 7 Bankruptcy?
Your legal responsibility to repay a secured debt is removed under the Chapter 7 discharge; however, the creditor still has the authority to repossess the property securing the debt. In the example of a mortgage, even though the Chapter 7 discharge got rid of your personal liability to repay the mortgage debt, the lender still has the right to foreclose on the property and sell it after your case is complete.
Under Chapter 7 bankruptcy, you can choose how to handle your secured debt. Your options include returning the property, reaffirm the debt, redeem the property, or keep the property and continue to make payments. Reaffirming the debt and continuing to make payments are essentially the same, although the lender may agree to wipe your late payments and let you continue on paying as normal. Redeeming the property usually involves paying the entire fair market value of the property (not an option for most people going through Chapter 7 bankruptcy.
Some unsecured debt will fall into the nondischargeable category, such as the priority debt discussed earlier in the article. All other unsecured debt will be discharged at the end of your Chapter 7 bankruptcy case. However, any funds left over after selling your assets and paying off secured and priority debts, will be paid out evenly to your unsecured creditors.
How Is Secured Debt And Unsecured Debt Handled In Chapter 13 Bankruptcy?
Chapter 13 bankruptcy involves creating a 3- to 5-year repayment plan that incorporates all of your secured and unsecured priority debt, and all or a portion of your unsecured debt. For example, if you have missed three payments on your $2,000/month mortgage and two payments on your $600/month car loan, the $7,200 will be included, along with any other appropriate debts, in the total to be paid over 3 to 5 years. To keep the secured debt property, you must continue to pay your regular monthly payments along with your bankruptcy repayment plan. In some cases, you can “cram down” secured debts to their fair market value, lowering your overall monthly payments.
Under Chapter 13 bankruptcy, nonpriority unsecured creditors must receive at least the total value of your nonexempt property. This maintains a degree of fairness for unsecured creditors, because the amount paid under a Chapter 13 bankruptcy should be the same as what would have been paid under a Chapter 7 bankruptcy. For example, if you own a non-exempt fancy piece of art worth $50,000, that amount is included in your repayment plan, on top of what you would pay for your priority debts and secured debts. Furthermore, any disposable income left after paying your plan approved expenses, secured debt, and priority debt goes into your repayment plan. Unsecured creditors are not guaranteed to receive any money in a Chapter 13 bankruptcy, and whatever unsecured debt is left at the end of your repayment plan is discharged.
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