What are Unsecured Debts?
I’m hungry. But I have no cash. And the Halal cart on the corner only takes cash. So, I went to my coworker and I asked her to borrow $10 to pay for a falafel platter. She handed me $10, I bought my food, and then I never paid her back. What is her recourse? Nothing. Nothing except for telling everybody else in the office that I am a deadbeat. That $10 is unsecured debt. It is that simple.
Compare that to this: I ask her to borrow the $10, and tell her that I am going to leave my autographed Kansas City Royals baseball card with her until I pay her back. If I do not pay her back, she keeps the card. That is secured debt – debt secured by some piece of property (otherwise known as collateral on the loan).
Sounds simple enough, right? So how do secured and unsecured debts play into an individual’s greater financial picture? And how do they play into a potential bankruptcy filing?
Examples of Secured Debt
The most important and financially impactful debt tends to also be secured debt. Examples include mortgages, car loans, and perhaps even small business loans if they are backed by some sort of collateral. If you’ve ever heard stories of a risky farmer or entrepreneur getting a loan from the bank on the basis of their house to pay for the next round of crops or products, that is secured debt.
For most people, secured debt basically means their home and their car. If you do not pay the mortgage, the lender can force a sale of your house via foreclosure. And if you don’t pay your car loan, the repo man will come by and take your car.
For most people, this is also the most important debt when it comes to bankruptcy. They may be willing to give up other assets, but need a place to live and a reliable vehicle to get to work. While a secured creditor cannot chase you down for payment while your bankruptcy filing is pending, they can still foreclose upon the property or repossess it after the bankruptcy case is over. It is also possible, depending on how much equity is in the property and whether it is exempt, the bankruptcy court trustee may force the sale of the property. For example, if your house is worth $20 million and your mortgage is only $200,000, but you owe $18 million to other creditors, the court will likely force the sale of your house in order to pay off some of that $18 million – after paying off the balance of your mortgage, of course.
There are exemptions in bankruptcy cases that will protect some of your property, such as a house up to a certain value and a car. But don’t expect to keep a $20 million dollar mansion or a Lamborghini – these exemptions are meant to apply to necessities, and accordingly, there are limits to the value of these exceptions.
Assuming your secured property is exempt from the bankruptcy court filing, and you want to keep it after the bankruptcy case is resolved, most lenders will negotiate with you and allow you to catch up on any past due balances and “redeem” your mortgage or car note.
What About Unsecured Debts?
Unsecured debt is what bankruptcy is all about. These are your personal loans, credit card balances, medical bills, past due utility bills, things like that. The creditor cannot recover from you by taking back the property – while we could certainly imagine some debt collectors trying to re-possess a body part for an overdue medical bill, it’s not legal to do so — so their interest in your bill is unsecured.
The recourse for a lender with an unsecured debt is to file a court case and try to get a judgment against you. Once they have that judgment, they can garnish wages, levy bank accounts, or try to put a lien on your property (depending on whether state law allows such things).
If you file bankruptcy while carrying a lot of unsecured debt, you may not get relief from all of it: priority debts, for one, will likely be paid and may not be dischargeable at all. Some examples of these include tax debt, alimony, and child support.
Student loans are an example that many people think are not dischargeable. And they are certainly unsecured – they can’t repossess your diploma. But it is actually a myth that student loan debt is nondischargeable, even if it is extremely hard to discharge it. Discharging student loan debt requires a special showing of an extremely large burden in keeping up with student loan payments, such as a disabled borrower who cannot longer make payments or someone who has tried repeatedly to pursue their career and only makes enough to cover rent, without extra income to to cover thousands of dollars in student loan payments each month.
For most other unsecured debt, such as payday loans, you stand a much better chance of discharging these debts in bankruptcy. The bankruptcy trustee will order the liquidation of any of your excess assets, such as extra cars, and will use that money to pay off the priority debts first, and some of your unsecured debt after that. But, once all the liquidated funds are exhausted, the rest of the debt under a Chapter 7 filing is wiped clean. (Most people file Chapter 7, while Chapter 13 handles debt very differently – it is more of a repayment plan than debt elimination).
Will Bankruptcy Help With Your Debt?
If you were looking at bankruptcy as a means to eliminate some of your past due debt or to stop the harassing phone calls of debt collectors, it may very well be the answer that you are looking for. The best first step you can take is to outline all of your assets and debts that you can find, including checking your credit report for past due bills that you may have missed. Take this information and discuss your situation with an experienced bankruptcy attorney to find out which debts and assets will be lost in the bankruptcy proceeding, and what can be preserved to help you get a head start on your new financial life after bankruptcy.