Secured Creditors in Bankruptcy

How Secured Creditors are Different from Unsecured Creditors in Bankruptcy

When a debtor files for bankruptcy, most of their debts will be held by either secured or unsecured creditors.  Understanding these types of creditors and how they are treated is important for successfully completing one’s bankruptcy.

A “secured creditor” is a person or business that loaned money in exchange for a lien on property securing payment for the money owed.  If a borrower fails to make payment, the secured creditor has the right to take possession of the collateral to offset their losses.  Some examples of secured creditors are:

• A bank that holds a mortgage on real property, if payments are not made by the borrower the bank has the right to foreclose on the property and repossess;
• A financial institution that has a lien on a vehicle;
• A leasing company, if payments are not made on the lease, the collateral is returned to the leasing company;
• Rent-to-own company;
• Collateral secured by a purchase money security interest (PMSI); and
• Fixtures secured by a UCC fixture filing.

Secured debts are treated differently based on which chapter a debtor files.  In a chapter 7, secured debts are not discharged like unsecured debts.  Instead, a debtor has the option of surrendering the collateral and discharging any liability on the debt.

Alternatively, the debtor may retain the property and either redeem the property or reaffirm the debt.

When a debtor redeems the property, they pay the current value of the property securing the debt.  For example, if a debtor owes $15,000 on a vehicle that is only worth $10,000, the lien holder is “under-secured”, which means they have a security interest in the vehicle for $10,000 and a $5,000 claim that is essentially unsecured.  A redemption in Chapter 7 would typically allow a debtor to eliminate the creditor’s lien on the vehicle by paying $10,000, the current value of the vehicle securing the loan.  The balance of $5,000 is then considered as unsecured and eligible for discharge. Redemption can be difficult because the debtor must come up with the entire amount of the redemption up front, payments cannot be made.

The other option for retaining secured collateral in a Chapter 7 is known as reaffirmation.  A reaffirmation agreement is a contract entered into between the debtor and the creditor in which the debtor promises to pay the entire amount due for the secured collateral.  In return for the debtors promise to pay, the creditor promises not to repossess the collateral.  Sometimes a debtor enters into a reaffirmation agreement to keep a creditor from going after a co-signor for the balance owed.  A reaffirmation agreement is filed with the court, which will determine that the agreement does not place an undue hardship upon the debtor and that it is made in the debtor’s best interest.

In a Chapter 13, secured collateral that is retained by the debtor can be paid through the Chapter 13 plan or sometimes by the debtor outside of the plan, local rules dictate how a debtor pays off secured loans in a Chapter 13.

Do you have secured creditors, or unsecured creditors, that hold debts you are struggling to pay?