Introduction to Secured versus Secured Debt
When considering bankruptcy and its possible effects, it is crucial to understand the three basic types of debts that exist: (1) unsecured, (2) priority, and (3) secured. Bankruptcy's effect on a particular debt depends largely on what type of debt it is.
What Is Unsecured Debt?
An unsecured debt is one in which the creditor does not have a lien on any of the debtor's property. Most ordinary debts are unsecured (e.g., credit card debt, doctor bills). Generally, unsecured debts may be discharged, or eliminated, in bankruptcy. However, certain types of unsecured debts are nondischargeable (e.g., credit card debt incurred for luxuary items just prior to filing for bankruptcy).
What is a Priority Debt?
A priority debt is an unsecured debt that Congress has decided should receive better treatment than others in the distribution of the debtor's assets. The most common priority claims include child support, alimony, taxes, student loans, claims of employees for wages and benefits (up to a certain amount), and deposits made by consumers for goods and services never delivered (up to certain amounts). In addition, the administrative costs necessary to file the bankruptcy case and keep it going--including the fees of lawyers, trustees and other professionals--called administrative claims, receive first priority treatment. Most priority debts are dischargeable in bankruptcy. Under a Chapoter 7 bankruptcy, priority status only means that if there are assets in the bankruptcy estate to be distributed, creditors with priority status will be satisfied before all other unsecured creditors. In a Chapter 13 bankruptcy, priority debt must generally be paid in full.
What is Secured Debt?
A secured debt is one in which the creditor has a lien on the debtor's property (mortgage on a home). The lien gives the creditor special rights to that property if the debt remains unpaid. Typically a lien held by a secured creditor cannot be eliminated in either a Chapter 7 or Chapter 13 bankruptcy. If the debtor wants to keep liened property, the debtor must pay the secured lienholder in full either during or after bankruptcy. However, bankruptcy does offer various ways of solving problems with secured debts and sometimes offers ways of eliminating liens.
There are several types of liens. The four most common are discussed below.
- Purchase-money security interest. If an asset such as a home, car or appliance was purchased with the money from the transaction in which the debtor agreed to the lien, it is called a purchase-money security interest (e.g. first mortgage).
- Nonpurchase-money security interest. If the underlying debt did not finance the purchase of the collateral (e.g. a second home equity loan), the lien agreed to by the debtor is called a nonpurchase-money security interest.
- Statutory lien. If by law a lien is a created without an agreement (e.g. tax lien), the lien is called a statutory lien.
- Judicial lien. Finally, if the lien results from the outcome of a court proceeding, it is called a judicial lien. In many states, when a civil court declares that someone owes a debt (judgment debtor), a lien is automatically placed on all of the judgment debtor's real estate within the county. In other states, after a judgement is rendered the creditor may ask a sheriff, or other judicial officer, to levy the personal property owned by the judgment debtor. The sheriff then attaches, or levies on, the personal property (e.g. bank accounts, stocks, vehicles, furniture, or anything else other than real estate). A lien on personal property is called a levy; another type of judicial lien.
In some cases, two or more creditors may have a lien on the same property. Usually, but not always, the creditor who obtained the first lien, sometimes called the senior lienholder, will have first dibs on the property liened. The fair market value of the property minus the total amount of the liens on a property will determine what equity, if any, the debtor has in the property. For example, assume a house is worth $250,000, and assume that there is a first mortgage of $150,000 and a second mortgage of $50,000 and a judgment lien of $5,000. The debtor's equity in the home is $45,000. However, where the liens on a property equal or exceed the the fair market value of the property, the owner-debtor has no equity or perhaps "negative equity" in the property.
As stated above, the liens held by many secured creditors cannot be eliminated in bankruptcy. If the debtor wants to keep the liened property, these debts must be paid in full either during or after the bankruptcy.
Hopefully this explanation will better help you determine whether or not bankruptcy will help you escape your debt. If most of your debt are secured, it probably won't do you much good, unless you are willing to forfeit the liened property. If, however, most of your debts are unsecured, bankruptcy might provide a means for you to start over with a clean slate.