A secured debt can be handled like an unsecured debt if you surrender the collateral, “avoid” a judgment lien, or just keep the collateral.
The “Discharge” of “General Unsecured” Debts
In our last few blog posts we have shown how “general unsecured” debts are handled under Chapter 7 “straight bankruptcy” and Chapter 13 “adjustment of debts.” Most of the time those debts are simply discharged—legally written off—under Chapter 7. They are also discharged at the successful completion of a Chapter 13 case, usually but not always after partial payment.
Debts that are secured by a lien on something you own are usually treated quite differently. The debt itself may well be discharged in the bankruptcy case just like an unsecured debt. But you also have a lien to contend with.
A lien is a creditor’s “interest in [your] property to secure payment of a debt.” (See Section 101(37) of the Bankruptcy Code.) A lien is not discharged in bankruptcy. It’s a property right that you have to deal with separately from the debt itself.
This actually makes common sense. If you finance the purchase of a vehicle, the lender is naturally a lienholder on the vehicle’s title. When you file a bankruptcy case, you can discharge the balance owed on the vehicle loan. But the lender will still have a lien on the vehicle, and so can repossess it if you don’t pay. Usually you have to agree to pay the balance in order to keep the vehicle.
As you can see secured debts are very different than unsecured ones.
But there are a few narrow exceptions, when you can act to turn a secured debt into an unsecured one. As we said in the introductory sentence, a secured debt can be handled like an unsecured debt if you
1. surrender the collateral,
2. “avoid” a judgment lien, or
3. sometimes, just keep the collateral.
1. Surrender the Collateral
Whether you have a vehicle loan, a home mortgage, or a store credit card with liens on everything you purchased, you can effectively turn the debt into an unsecured one by giving the collateral to the creditor.
Admittedly that’s not helpful if want to keep the collateral. But there are many situations where surrendering the collateral is well worth the benefit of not paying the debt.
With vehicle loans you would often owe a substantial amount of money even after surrendering the vehicle outside bankruptcy. Surrendering the vehicle in bankruptcy lets you get out of a bad deal without having to pay a small fortune.
We’ll talk about this more and give a couple practical examples in our next blog post.
2. “Avoid” the Judgment Lien
If you own a home just about any unsecured creditor can turn the debt into one secured by the home. Suing you and getting a judgment against you in most states gives the creditor a judgment lien on your home.
Bankruptcy can in many cases empower you to “avoid”—permanently get rid of—a judgment lien on your home. This “avoidance” can be done under either Chapter 7 or 13. It requires the right combination of several numbers—the amounts of the judgment lien, the equity in your home, and your allowed homestead exemption.
We’ll dig into when this works and give examples a couple blog posts from now.
3. Keep the Collateral Without Paying
Sometimes a secured creditor just doesn’t care enough about the collateral to bother making you surrender it. Or sometimes it’s not clear whether the creditor even has a valid lien. It may not want to risk repossessing something that it does not have the legal right to repossess.
In these situations the best option may simply be to file bankruptcy and act as if the debt is unsecured. That is, don’t pay it and see whether the creditor asserts any rights in the collateral.
This option comes with some risks, which we’ll explain and make clear with some examples in an upcoming blog post.