Understanding the Difference between Secured and Unsecured Debt

As those who have sought the relief from debt bankruptcy provides know, Chapter 13 and Chapter 7 bankruptcy do not treat secured debt and unsecured debt equally. For this reason, it is necessary to understand the difference between these two types of debt.

Secured versus Unsecured Debt

The main difference between secured debt and unsecured debt is collateral. Secured debt is debt that is backed by collateral, like a house or a car. Examples of secured debt include mortgages and car loans. Creditors are able to repossess the home or car if individuals default on their secured debt.

Unsecured debt is debt backed by an individual's promise to pay the loan. Examples of unsecured debt include credit card debt and medical debt. Since the debt is backed by an individual's good word, creditors cannot collect tangible collateral when an individual defaults.

Chapter 13 Bankruptcy's Treatment of Secured and Unsecured Debt

Chapter 13 bankruptcy, also known as the wage earners plan, establishes repayment plans for eligible filers. Because Chapter 13 enables filers to repay all or part of their debt, there are limits on how much secured and unsecured debt filers may have. Individual filers may not owe more than $250,000 in unsecured debt or $750,000 in secured debt. Owing debt above these limits makes filers ineligible for Chapter 13 bankruptcy.

Under Chapter 13, it may be possible for filers to keep secured debt possessions like their homes or cars. Under a repayment plan, secured debt for a home or car can be reorganized so payments are manageable, allowing filers to stay in their homes or keep their cars while they pay off their debt.

Treatment of unsecured debt is a little more complicated. To determine how much unsecured debt must be repaid, bankruptcy courts look at what is owed and compares it to how much creditors would have received if an individual was filing under Chapter 7 bankruptcy. They also look at a filer's income and how much total debt he or she owes.

Chapter 7 Bankruptcy's Treatment of Secured and Unsecured Debt

Chapter 7 bankruptcy discharges an eligible filer's debt through liquidation of his or her assets. Chapter 7 bankruptcy wipes out unsecured debt, though some of the filer's property may be liquidated to pay back creditors at least in part.

Chapter 7 filers have some choice about what happens to their secured debt. They can choose to have their creditors repossess the items as collateral, continue to make payments to repay the debt or pay the creditor a sum equal to the replacement value of the property in question. A filer must reaffirm that he or she owes the debt and agree to make payments to avoid secured creditors repossessing property after the bankruptcy process is complete.

The bankruptcy process is complicated and not all filers are eligible for all types of bankruptcy. To understand what type of bankruptcy for which you meet requirements, please contact an experienced bankruptcy attorney.