Filing for bankruptcy is a significant decision that can provide relief from overwhelming debt. However, not all debts are treated the same in bankruptcy. One of the key distinctions the court makes is between secured debt and unsecured debt. Understanding how each type of debt is handled in bankruptcy can help individuals and families make informed decisions.
At Checkett, Pauly, Bay & Morgan, LLC, we have the experience needed to guide clients through the bankruptcy process in Carthage, Missouri and Nevada, Missouri. Here, we explore the differences between secured and unsecured debts, how they’re treated in Chapter 7 and Chapter 13 bankruptcy, and what individuals can expect when filing for bankruptcy protection.
The Basic Types of Debt
Before explaining the bankruptcy processes, it’s important to clarify the difference between secured and unsecured debt. Not all debt is treated equally in bankruptcy court, so knowing the difference can protect your assets and help you make informed decisions. Here’s what you need to know about the basic types of debt.
What Is Secured Debt?
Secured debt is a type of loan that is backed by collateral. This means there is a physical asset tied to the loan, which the lender can claim if the borrower defaults. Secured debt is backed by something valuable, like a house, car, or savings account. This collateral protects the lender in case you can’t make payments. Common examples include:
Mortgages: Secured by real estate
Car loans: Secured by the vehicle
Secured personal loans: Tied to savings accounts or other property
Because these loans are tied to specific property, lenders have a legal right to reclaim that asset. They may repossess or foreclose on it if the borrower fails to meet the loan terms. Our attorneys at Checkett, Pauly, Bay & Morgan, LLC can help you determine if you have any debts that would be considered secured.
What Is Unsecured Debt?
Unsecured debt has no collateral backing it. This means there is no physical asset, like a car or house, that a lender can take back if the borrower stops making payments. Instead, creditors rely entirely on the borrower’s promise to repay the loan and their creditworthiness. These loans are riskier for lenders and often come with higher interest rates. Common examples include:
Credit card debt
Medical bills
Personal loans not tied to property
Utility bills
Since there's no property securing the debt, creditors don’t have the automatic right to repossess anything. If they want to collect, they typically must sue the borrower in court, win a judgment, and then pursue collection through garnishment or liens. If you’re facing bankruptcy while carrying unsecured debt, our lawyers at Checkett, Pauly, Bay & Morgan, LLC can help.
How Secured Debt Is Treated in Bankruptcy
When someone files for bankruptcy, the way their secured debt is handled depends largely on the type of bankruptcy they pursue. Bankruptcy doesn’t automatically eliminate secured debt - it offers options for managing or eliminating it, but usually at a cost. Understanding your rights and choices is key to protecting your property and getting meaningful relief.
In Chapter 7 Bankruptcy
Chapter 7 bankruptcy is the most common form of bankruptcy for individuals who have limited income and few assets. Chapter 7 provides a relatively fast path to debt discharge, often within a few months. However, if you have secured debt, you must make specific decisions about how to deal with the property tied to those loans.
Reaffirmation, Redemption, or Surrender
When it comes to secured debts like car loans or mortgages, Chapter 7 filers generally have three main options to consider, depending on the value of the asset, the loan balance, and their financial priorities. An experienced attorney can help you decide which option is the recommended route for your situation. Here are the choices:
Reaffirm the debt: Agree to continue paying the debt even after bankruptcy. This keeps the asset (like your car or home), but you remain liable for payments.
Redeem the asset: Pay the current value of the property in a lump sum, which may be less than the outstanding loan balance.
Surrender the asset: Give up the property to the lender and discharge the debt. The lender takes possession, but you’re no longer liable for any deficiency.
Deciding how to handle secured debt in Chapter 7 bankruptcy is a major financial decision that depends on your specific circumstances, including the value of the property, your loan balance, and your ability to continue making payments. Each option has benefits and risks, and what works for one person may not work for another.
Foreclosure and Repossession
If you're behind on payments when you file for Chapter 7 and don’t reaffirm or redeem the debt, the lender can reclaim the asset. Although bankruptcy temporarily halts these actions, the protection is temporary. Once the court lifts the stay or the bankruptcy process ends, lenders can move forward with reclaiming their collateral.
Missouri-Specific Exemptions
Missouri allows certain bankruptcy exemptions to protect some of your property. For example, the homestead exemption protects up to $15,000 of equity in a primary residence and up to $3,000 in a motor vehicle. If the equity in your secured property exceeds the exemption, the trustee may sell it to repay creditors.
In Chapter 13 Bankruptcy
Chapter 13 bankruptcy is often referred to as a “wage earner’s plan” because it allows individuals with regular income to restructure their debts and create a repayment plan. Instead of liquidating assets, Chapter 13 focuses on helping debtors catch up on missed payments and pay off debt over time, letting you keep your property, even if you're behind on payments.
Repayment Plan for Secured Debts
Secured debts are prioritized in a Chapter 13 repayment plan. Filers typically continue paying on mortgages and car loans through the plan. The plan may include arrears for payments missed, giving filers time to catch up. The key here is consistency. If you miss payments during your Chapter 13 plan, you risk losing the asset despite having filed for bankruptcy.
Cramdowns and Stripping Liens
Chapter 13 may allow for cramdowns, reducing the loan balance to the current value of the collateral, particularly with car loans. Missouri filers may also be able to strip junior liens (like second mortgages) on a home if it’s worth less than the amount owed on the first mortgage. These tools make Chapter 13 attractive to those with valuable property they want to keep.
How Unsecured Debt Is Treated in Bankruptcy
Unsecured debt plays a major role in most personal bankruptcy cases, and how it’s treated can vary significantly depending on the type of bankruptcy filed. Unlike secured debt, unsecured debt has no collateral backing it. This means creditors don’t have a specific asset they can repossess or foreclose on if the borrower defaults.
In Chapter 7 Bankruptcy
Chapter 7 bankruptcy offers individuals a fresh start by allowing them to discharge most of their unsecured debts, giving them a clean slate. This is often the primary reason people choose Chapter 7. Once the bankruptcy is complete, creditors can no longer pursue collection actions on these discharged debts. This includes the following:
Credit card debt
Medical bills
Past-due utility bills
Unsecured personal loans
However, not all unsecured debts can be wiped out in Chapter 7. There are important exceptions to be aware of, since there are certain types of unsecured debt that are considered non-dischargeable under federal law. Understanding what falls within these exceptions is important for developing a plan. These exceptions include:
Student loans
Child support and alimony
Recent taxes
Debts from fraud or willful injury
In a Chapter 7 case, unsecured creditors only receive payment if the trustee recovers funds by selling the debtor’s non-exempt property. In Missouri, most individual Chapter 7 filers have little to no non-exempt property, meaning many unsecured creditors receive nothing. Despite that, the debts are still discharged, offering full relief to the debtor.
In Chapter 13 Bankruptcy
Chapter 13 bankruptcy takes a different approach to unsecured debt by using a structured repayment plan. Instead of immediately discharging the debt, Chapter 13 requires monthly payments to a bankruptcy trustee, which are then distributed among creditors according to a court-approved plan. The amount paid toward unsecured debt depends on several key factors:
The debtor’s income and expenses
The value of non-exempt property
The length of the repayment plan
One of the key benefits of Chapter 13 is that, once the repayment plan is completed, any remaining balance on eligible unsecured debts is discharged. This can result in substantial savings for debtors, especially those with large amounts of credit card or medical debt, making Chapter 13 an appealing choice for some individuals.
Get Legal Guidance Before Filing
Bankruptcy offers powerful tools for debt relief, but it’s not a one-size-fits-all solution. Knowing how secured and unsecured debts are treated can help you approach the process with realistic expectations. At Checkett, Pauly, Bay & Morgan, LLC, we offer compassionate, knowledgeable guidance to help individuals and families regain financial control in Carthage, Missouri, and Nevada, Missouri. We’re here to help you explore your options and build a better future. Contact us today to start working together.
