Power Over Your Secured Creditors in Chapter 7
Your secured debts are often the ones you most care about, because the creditor can take your collateral. Chapter 7 strengthens your hand, improving your options.
A secured debt is usually one in which your agreement to pay a debt is backed up with some collateral. If you don’t pay, the creditor can take possession and ownership of that collateral. So, a mortgage holder can foreclose on your home, a vehicle lender can repossess your vehicle, and the appliance store can haul away your washer and dryer.
But for the creditor to have rights to your collateral—for the debt to be truly “secured”—the creditor needs first to have gone through the appropriate legal steps to tie the collateral to the debt. Some debts that look like secured debts are legally not. In the above example of the washer and dryer, whether or not the creditor can repossess your appliances depends on whether it followed the law to tie them to the debt.
Besides secured debts in which you voluntarily gave the creditor rights to the collateral, there are many kinds of secured debts in which the creditor got those rights by operation of law. This happens without your consent, sometimes even without your knowledge, often as part of the debt collection process. An example is an IRS tax lien recorded against your real estate and/or personal property for non-payment of income taxes.
Power Provided by Chapter 7
A Chapter 7 case can help with both voluntary and involuntary secured debts. It will 1) temporarily or permanently prevent your creditor from taking your collateral; 2) help you keep the collateral; and 3) if you want, enable you to surrender the collateral to the creditor without economically hurting yourself.
Power # 1: Stop the Creditor from Taking the Collateral
The moment your Chapter 7 case is filed, all your secured creditors are immediately stopped from taking possession of your collateral. This is the same power that stops all collection activity by all your creditors again you and your property. You may hear this referred to as the “automatic stay.”
Very importantly, not only does the “automatic stay” stop secured creditors from chasing previously agreed to collateral, also stops unsecured creditors from becoming secured ones, such as by stopping the IRS from getting a tax lien. Since secured creditors have tremendously more leverage, inside and outside of bankruptcy, this is a very helpful power that bankruptcy gains for you.
Power # 2: Keep the Collateral
Whether the collateral on a secured debt is your home, vehicle, appliances, or everything you own (as with an IRS tax lien), if you want to keep the collateral or whatever is included in a lien, bankruptcy can help in a variety of ways, including:
- If you are current on a secured debt and want to keep the collateral—such as with a vehicle loan—you can virtually always do so. Your creditor may well be legally required to continue the relationship as originally agreed if you have upheld your end of the bargain. And practically speaking, it will be very pleased to allow you to keep the account in good standing. This is also a good way for you to get a head start on rebuilding your credit.
- If you are not current on your payments, you will generally be given a limited amount of time to bring the account current. How much time will depend on the type of secured debt, and the flexibility of the creditor. Since you are no longer paying most or all of your other creditors, this may be a feasible option for you. (If you need more time to catch up on your vehicle or other loan, Chapter 13 may be a better option.)
- In some situations, the loan terms can be changed to waive payment of any missed payments, to lower the interest rate, and perhaps even lower the balance.
- Select kinds of secured debts—for example, judgment liens on your home—can be “avoided”—stripped off your home title.
- And maybe most obviously, a very legitimate reason to file a Chapter 7 case is to discharge other debts so that you can afford to pay your vehicle, home or other important secured debts.
Power # 3: Dump the Collateral
Outside of bankruptcy, simply surrendering collateral to the creditor because you do not need or want it any longer, or just can’t afford to pay for it, is often not an economically sensible option. That is because you can end up still owing much of the debt after the creditor sells the collateral for substantially less than the amount of the debt, adds all of its sale costs to the debt, and then sues you for the remaining “deficiency balance.”
And if instead the creditor just forgives that balance, in some situations you can be hit with a serious income tax obligation. The amount forgiven may be considered “cancelation of debt income” upon which you may be required to pay income taxes.
Chapter 7 solves both of these problems. Except in very unusual situations, it would discharge (permanently write off) any “deficiency balance” after the surrender of any collateral. And the discharge of debts in bankruptcy is not considered “cancelation of debt income,” so you don’t have the risk of it is being taxed. As a result, you can freely surrender collateral in a Chapter 7 case if you want to, without worrying about owing the creditor or owing taxes for doing so.