Will Chapter 13 Bankruptcy Work for You?

« Back to Home

Dealing With Both Secured and Unsecured Debts During Bankruptcy

Posted on

It's not uncommon for folks who are facing bankruptcy to be dealing with both secured and unsecured debts. How you might address each situation is a question for a bankruptcy attorney, and here are three things they're likely to mention regarding the topic.

The Distinction Between the Two

Secured debts are ones that are backed by a physical object. For example, when you take out a car loan, the ability of the bank to repossess the car is what secures the debt. If you fail to pay, the bank isn't out the value of what it loaned you because they can take back the vehicle and recoup at least part of what they lent. Unsecured debts are ones that are only backed by what's known as your "full faith and credit." In other words, if a bank loans you money and the only thing that secures the debt is your promise to repay it, this is an unsecured debt. This is common with financial instruments like credit cards and personal loans.

Why That Matters

From the perspective of a bankruptcy lawyer, the distinction here matters because it may require two separate petitions for relief. This occurs because unsecured debts can be discharged through Chapter 7, but secured ones would usually need to be restructured under Chapter 13 for personal debts. A bankruptcy lawyer can use a process that's known in the industry as "Chapter 20." (7 plus 13 equals 20. Get it?) In this process, the petitioner files for Chapter 7 and liquidates assets to pay off unsecured creditors. Once that's done, they file for Chapter 13 and create a payment plan to pay off the secured creditors at a reduced cost. A less common approach where restructuring comes before liquidation is sometimes used, but that's less common.

Is This Necessary?

This approach isn't always for the best. For example, filing just for Chapter 7 may be sufficient to get your financial situation under control. You can then use the financial resources freed up from no longer servicing your unsecured debts to pay down the secured ones.

It may also be possible to negotiate directly with the holders of your secured debts. Essentially, this is still restructuring, but you'd be doing it outside the bankruptcy system. A major plus for this approach is that you may still be able to file for bankruptcy restructuring at a later time if you prove unable to pay.