Crucial Question: In a Chapter 7 Case, How Do You Keep Collateral That’s Not a Home or Vehicle?
Have your attorney first make sure that your creditor has a right to the collateral. If so, arrange to pay for the right to keep it.
Personal and Business Collateral
People thinking about filing bankruptcy are understandably most interested in what happens to their biggest kinds of collateral—their home and vehicle(s). So just as understandably, attorneys’ websites focus on those big ticket items.
But what about other kinds of collateral that you value: your furniture and appliances, personal electronics like your cell phone, your and your spouse’s wedding rings? These can be awfully important, too.
Or if you own a business, what loans on your office equipment, the tools of your trade, or perhaps even your inventory? How these debts and assets are treated in bankruptcy can have a huge effect on your livelihood going forward.
The Difference between Collateral and Other Assets
Bankruptcy treats collateral on a debt very differently than other things you own that are not collateral. So it’s important to know the difference.
If you have a creditor which has a debt that you owe to it that is secured by collateral, that creditor has a right to take that collateral from you if you do not pay the debt. Its rights to the collateral in that situation come ahead of your right to keep it. It usually can repossess that collateral without suing you.
In a Chapter 7 bankruptcy, you must usually pay all or at least part of the secured debt if you want to keep the collateral.
If instead you have a creditor which has a debt that is not secured by any collateral, that creditor has no right to take anything from you without suing you. It is an unsecured debt.
In a Chapter 7 bankruptcy, you can usually “discharge” (legally write off) most unsecured debts without paying anything because they are not legally tied to any collateral.
Distinguishing between Secured and Unsecured Debts
Considering how differently a secured debt is treated compared to an unsecured debt, it’s crucial to distinguish between them.
With a home mortgage or a vehicle loan you usually simply know with near certainty that the home is collateral on the former and the vehicle is collateral on the latter. And these can be easily confirmed either by looking at the loan documents or by contacting the county recording office or the state department of motor vehicles, respectively.
With other kinds of potentially secured debts, it’s not always so easy. For example, when you buy a washing machine the creditor may or may not go through the legal hoops for the washing machine to be collateral on the debt.
Different states have different rules about the procedure to be used for creating a legally binding secured debt. And the rules can be very different depending on whether the debt was entered into to purchase the collateral or instead you took out a loan and provided collateral that you owned beforehand for the loan.
So if you can, you should bring to your attorney any documentation you might have on the purchase and/or financing. You certainly wouldn’t want to pay off a creditor for the right to keep something if it is not legally collateral on the debt. Nor would you want to have a creditor take something from you that you need because you didn’t realize that it was collateral on a debt.
Once you determine that a debt is secured by collateral that you want to keep, generally you will have to pay for the right to keep the collateral by “reaffirming” the debt or a portion of it. Generally you would continue making the contract payments on the debt. But if the collateral is worth less than the debt, your attorney may be able to arrange for you to pay less than the full loan balance to keep that collateral. Reaffirming the debt or a portion excludes that from the discharge of the rest of your debts. Once you pay off the reaffirmed amount, you own the collateral free and clear of the debt.
You can also keep collateral by paying its fair market value in a lump sum. Although coming up with the money to do that may be a challenge, your attorney may know of lenders who are in the business of lending money to people in bankruptcy in order to redeem collateral (although this tends to be available only for vehicles and similar more valuable collateral). The advantage is that your secured creditor must accept a redemption payoff. You avoid the creditor forcing you to pay the full debt over time in return for being able to keep the collateral. So, in the right circumstances redemption can be a helpful way to keep collateral, especially collateral worth less than the debt amount.
Keeping Without Paying
Even if your creditor’s debt is legally secured by certain collateral, with collateral worth relatively little sometimes it’s worth doing nothing during your Chapter 7 case, offering to pay nothing, and then seeing if the creditor does anything to repossess the collateral. Many creditors do not find it cost-effective to chase down collateral that’s of low value, depreciates quickly, is easily transferable, or would resell for not much. Examples are computers, modest jewelry and gifts, and small appliances.
If a debt is legally secured by the collateral, during the Chapter 7 case the creditor generally may not repossess without bankruptcy court permission. Then once the case is over—usually only about 3 months after it is filed—the creditor can usually act unilaterally and without prior notice to repossess. The underlying debt is usually discharged, but the creditor’s right to its collateral is generally not affected. However, if you have some collateral that is not worth more than a few hundred dollars, and you’re willing to risk post-bankruptcy repossession in return for the chance not to pay anything for it, talk with your attorney about whether your creditor tends to chase your particular kind and value of collateral. You may well save a few hundred dollars.