Making Sense of Bankruptcy: How Does Chapter 7 Handle the Collateral Securing My Debts?
When you file a Chapter 7 “straight bankruptcy” case you can keep and pay for collateral or return it and not pay the debt.
Here’s today’s sentence that we’re explaining to help make sense of bankruptcy:
If a debt is truly secured by collateral you usually have the option of keeping that collateral and paying the debt—likely in full regardless of the value of the collateral—or giving the collateral back to the creditor and usually paying nothing more on that debt.
Verifying that the Collateral Actually Secures the Debt
A debt that is legally secured by something you own is handled very differently in bankruptcy than a debt which is not secured by anything more than your commitment to pay the debt. (For the sake of convenience, we’ll call the asset that a secured debt has a lien on “collateral”.) Most debts that are unsecured are simply discharged—legally written off—in bankruptcy without anything being paid on them. With debts that are secured you need decide whether you want to keep the collateral, which will determine whether you will pay the debt or not, and sometimes when and how much you’ll pay.
Usually it’s very clear when a debt is in fact secured, such as a vehicle loan in which your lender is on the title as lienholder, or a mortgage loan with the mortgage recorded in county records on the title to your home. But sometimes it’s not so clear—a debt you thought was secured is not, and one you thought wasn’t secured might be. For example, if you bought a vehicle from a relative and still owe on it, you may both think the vehicle is collateral on that debt. But if you didn’t go through the appropriate legal steps that debt would likely actually be unsecured. Or if you bought some merchandise on a store credit card, you may think that’s an unsecured debt but the credit card agreement may provide that anything purchased on the card secures the debt until the purchase price of each item is paid off.
So it’s worth looking at the appropriate paperwork to find out whether a debt is secured or not, something your attorney will help you with.
When You Can and Cannot Keep Collateral
Most of the time creditors are happy to let you keep collateral if you are willing to pay the debt. But not always, especially if you are behind on the payments.
With vehicle loans, for example, in a Chapter 7 case most creditors require you to catch up on any late payments and do so quickly or else they won’t let you keep the vehicle. Usually you have to catch up within a month or two of filing your case. It is rare for lenders to give you more time, or to put those late payments to the end of the loan, although some lenders may be more flexible. (You can usually force your lender to be much more flexible in a Chapter 13 “adjustment of debts” case, but our focus here is on Chapter 7.)
With home mortgages, most lenders will allow you to enter into a forbearance agreement requiring you to pay extra each month beyond your regular mortgage payment to catch up on the late payments. But it’s up to your lender whether to make such agreements available and whether to make the extra payments low enough so that you can afford them. Otherwise you won’t be able to keep your home. (Again, Chapter 13 may be a better option then—see our blog post of 3 weeks ago about getting much longer to catch up on a mortgage arrearage while being protected from foreclosure and other actions of your mortgage lender.)
If you are current on a secured debt, or are almost current and can catch up quickly, you will likely be able to keep the collateral in a Chapter 7 case.
Paying the Debt in Full or Less
If your secured creditor is allowing you to keep the collateral, most of the time you will have to pay the debt in full and do so under the terms of the original contract in order to keep the collateral.
Certain creditors may be more flexible, allowing you to pay less than the full balance to keep the collateral, especially if the collateral is worth much less than the balance. Such a creditor would be facing the fact that if it would instead repossess and sell the collateral, it would receive proceeds much less than the amount of the debt. So such a creditor would be as long as it gets you to pay more than it would have received by repossession and sale.
But again most creditors will require you to pay the debt in full regardless of the value of the collateral.
Also, you will very likely be required to enter into a “reaffirmation agreement,” a formal and legally binding, court-approved commitment to pay the debt BY EXCLUDING that debt from the discharge of your debts. That it, not only do you have to pay the debt (again, usually in full), your initial contract to pay the debt continues to be legally enforceable after the Chapter 7 case is completed. This means that if you ever fail to make the payments, the collateral could still be repossessed and you would likely continue owing most of the debt.
The Collateral Return Option and Timing
If you instead decide to surrender the collateral to the creditor, you would give notice of this to the creditor through a “Statement of Intent” filed at the bankruptcy court at or near the beginning of your Chapter 7 case. Usually you would have to give back the collateral within a month or so of your Chapter 7 filing, with the timing depending on the nature of the collateral. Vehicles usually have to be surrendered quite quickly; a home can often take much longer, depending on the aggressiveness of the lender and sometimes on its backlog of foreclosures and foreclosed homes in its inventory.
Paying No More When Returning Collateral
Often the biggest benefit to surrendering collateral in a Chapter 7 case is that you would almost never have to pay that debt. Giving back the collateral turns the debt into an unsecured one, one which would be discharged along with all or most of your other unsecured debts.
The exceptions to discharge would be for the same as any other unsecured debts—if you got the debt through fraud or misrepresentation or other similar bad actions you could be forced to pay it even after surrendering the collateral. An example would be a vehicle loan that a debtor would have received as a result of false information he or she put on a credit application in order to procure the loan.
But these are quite rare. Virtually always if you give to a secured creditor the collateral securing the debt, that debt will be discharged and you will not pay anything more on it at all.