Secured vs Unsecured Debt in Chapter 7 Bankruptcy

When you file for Chapter 7 bankruptcy, you don't have to directly repay any of your debt. Instead, the bankruptcy trustee may take any property you own that isn't exempt, sell it, and distribute the assets to your creditors. Once this process is complete, you will receive your bankruptcy discharge, which wipes out all debts that can be discharged in bankruptcy.

What happens to each of your debts in Chapter 7, including whether those creditors are paid, whether the debts are wiped out, and whether you have any continuing obligations once your bankruptcy case is over, depends on whether they are secured or unsecured, and whether they are considered priority debts.

Secured Debt

A secured debt is one that is secured by property, which the creditor can take if you default. For example, your mortgage is secured by your home. If you default on your loan, the lender can sell your home to repay your debt. A car loan is also a secured debt. In addition to these voluntary security agreements, there are some types of secured debts that you might not have agreed to. For example, if you owe taxes, the IRS might get a tax lien against your home.

When you file for Chapter 7 bankruptcy, your personal liability to repay a secured debt is discharged. However, the creditor still has the right to take back the property securing the debt. For example, if you have defaulted on your mortgage, the lender will still have the right to foreclose on the property and sell it once your bankruptcy case is over. However, if the house is worth less than you owe, the lender won't be able to sue you for the difference (called a deficiency judgment).

As part of your Chapter 7 paperwork, you'll have to tell the court and your creditors how you want to handle your secured debts. The simplest option is to give back the property. If you want to keep the property, you will have to reaffirm the debt (agree that you will still owe it after your bankruptcy is over), redeem the property (pay the creditor its fair market value), or, if the creditor agrees, keep the property and continue making payments. (For more on these options, see Understanding the Statement of Intention in Chapter 7 Bankruptcy.)

Unsecured Debt

In contrast, unsecured debt is debt that is not secured by collateral, such as credit card debt, medical bills, or lawsuit judgments against you. Unsecured creditors cannot take any property to satisfy their debts. Instead, they typically have to file a lawsuit against you and win before they can initiate collection proceedings.

If you have any nonexempt property, the trustee will take it, sell it, and distribute the proceeds to your unsecured creditors. (If the property is the security for a debt, the secured creditor will be paid first. For example, if you owe $5,000 on a car that's worth $9,000, the holder of your car note will receive its $5,000, and the remaining $4,000 will be distributed to your unsecured creditors.)

Unsecured creditors are paid in order of priority. Priority debts are those that, for public policy reasons, are repaid first. These include child support, spousal support, money you owe to employees, and tax debts.

If any money is left after your priority debts are paid, it will go to your other unsecured creditors, such as credit card companies.

At the end of your bankruptcy case, you might still owe certain unsecured debts. Debts that cannot be discharged in bankruptcy include child support, student loans (with some exceptions), and many types of tax debts. Unless a debt falls into a nondischargeable category, however, it will be wiped out at the end of your bankruptcy case. (For more information on which debts are discharged in bankruptcy and which are not, see Bankruptcy Discharge: Which Debts Are Wiped Out?)