Chapter 5 Secured Debts

• Library: How to File for Chapter 7 Bankruptcy (Nolo) (2022 Ed.)

CHAPTER 5 Secured Debts

What Are Secured Debts?

Security Interests

Nonconsensual Liens

What Happens to Secured Debts When You File for Bankruptcy

Eliminating Liens in Bankruptcy

If You Don't Eliminate Liens

Options for Handling Secured Debts in Chapter 7 Bankruptcy

Option 1: Surrender the Collateral

Option 2: Redeem the Collateral

Option 3: Retain and Pay (the "Ride-Through" Option)

Option 4: Reaffirm the Debt

Option 5: Eliminate (Avoid) Liens

Lien Elimination Techniques Beyond the Scope of This Book

Choosing the Best Options

What Property Should You Keep?

Real Estate and Motor Vehicles

Exempt Property

Nonexempt Property

Step-by-Step Instructions

How to Surrender Property

How to Avoid Liens on Exempt Property

How to Redeem Property

How to Reaffirm a Debt

This chapter explains how Chapter 7 bankruptcy affects secured debts: debts that give the creditor the right to take back a particular piece of property (the collateral) if you don't pay. We tell you how to recognize a secured debt when you see one and explain your options for dealing with secured debts (and the collateral that secures them) in bankruptcy. This chapter ends with step-by-step instructions on several simple procedures for handling secured debts. (If you opt for one of the more complex procedures, we explain the basics, but you'll probably need the help of a lawyer.)

Here's a brief summary of what's likely to happen to your secured debts and the property that secures them. First, the bad news:

• If you have a mortgage on your home or a home equity loan, bankruptcy will eliminate the debt, but not the underlying lien. The same is true for other secured debts such as car notes and installment payments on business equipment.
• If the government has a lien on your home for unpaid taxes, you can't remove it even if the tax debt itself is discharged in your bankruptcy.

Now, the good news:

• If your property has a lien on it because of a judgment that someone got against you in civil court (a money judgment), you can often get the lien removed. While you can do this yourself (it's called lien avoidance), it's typically more complicated than the bankruptcy itself.
• If you want to get out from under your loan on a car, house, or other property, and return the property without any further liability, you can do it in your bankruptcy case. This is called "surrendering" the collateral.
• If you owe a lot more than the collateral is worth, in some cases you can redeem it—that is, buy the property at its replacement value (what you could buy it for, considering its age and condition). You'll need to come up with a lump-sum payment or arrange for financing; creditors rarely accept installment payments.
• If you aren't in a position to redeem the property but are current on your payments, you might be able to get rid of (discharge) the underlying debt and keep your property by staying current on the payment. This is called the "ride-through" option.
• You can usually keep your car or other personal property by reaffirming the debt and remaining current on your payments. When you reaffirm a debt, you remain personally liable for the debt after the bankruptcy.

That's the big picture for the most common kinds of secured debts. Now it's time to learn the details about:

• which of your debts are secured
• which secured debts you can turn into unsecured ones (via lien avoidance), and
• how to deal with the obligations that remain secured.

RELATED TOPIC

Dealing with leased cars and other property. This chapter addresses secured debts—debts secured by collateral that the borrowers are purchasing or already own. However, many people choose to lease rather than buy their cars (and equipment and commercial space, if they are in business). You must list all leases on Schedule G, then indicate on your Statement of Intention whether you will assume the lease (meaning the lease will continue in effect as if you'd never filed for bankruptcy) or reject the lease (meaning you can walk away from all rights and obligations under the lease). In some bankruptcy courts, you'll also have to get approval from the court in a reaffirmation hearing to assume the lease.

See below for more on reaffirmation hearings. Also, some courts require a written "assumption agreement." You can find more information on leases in bankruptcy, and how to complete these forms, in Ch. 6.

TIP

Chapter 13 might provide better protection for secured property you want to keep. As explained in Ch. 1, debtors who use Chapter 13 can "cram down" many types of secured debts. In a cramdown, the court reduces the principal owed on the debt to the property's replacement value (and often reduces the interest rate, too). Although you can't cram down mortgages on your home or newer car loans, many other types of debts are eligible. If you are significantly upside down on a secured debt and you want to keep the collateral, review the material in Ch. 1 to make sure Chapter 7 is the right bankruptcy choice.

What Are Secured Debts?

A debt is secured if it is linked to a specific item of property, called collateral, that guarantees payment of the debt. Mortgages and car loans are the most common examples of secured debts. If you don't make your payments when they come due, the creditor can repossess the collateral. Often, the collateral is the property you purchased with the debt. For example, a mortgage typically gives the lender the right to foreclose on your home if you don't pay. However, you can also pledge property you already own as collateral for a debt. For example, assume you inherit a new car from a parent, and the car is paid for in full and worth $20,000. You can use the car as collateral for a bank loan—the bank will put a lien on the car as security for repayment of the loan.

An unsecured debt, on the other hand, is not secured by any type of collateral. Credit card and medical debts are typical examples of unsecured debt. Debts owed to lawyers and other professionals are also typically unsecured, as are "deficiency judgments" arising from foreclosures and car repossessions (if the lender sells the property for less than you owe, the remainder of the debt is called a deficiency judgment).

For bankruptcy purposes, there are two types of secured debts:

• those you agree to (called security interests), such as a mortgage or car note, and
• those created without your consent, such as a lien the IRS records against your property because you haven't paid your taxes.

Security Interests

Security interests are secured debts you have taken on voluntarily. If you pledge property as collateral for a loan or line of credit—that is, as a guarantee you will repay the debt—the lien on your property is a security interest. A security interest created to buy the collateral is called a purchase-money security interest. If you use property you already own as collateral (for instance, you refinance a car or pledge business assets as collateral for a loan), the debt is a non-purchase-money security interest. These two types of security interests might be treated somewhat differently in bankruptcy, as discussed later in this chapter.

Usually, you must repay a security interest by making installment payments. If you fail to make your payments on time or to comply with other terms of an agreement (for example, a mortgage lender's requirement that you carry homeowners' insurance), the lender or seller has the right to take back the property.

Lenders Must Perfect Their Security Interests

For bankruptcy purposes, security interest agreements qualify as secured debts only if they have been perfected: recorded with the appropriate local or state records office. For instance, to create a lien on real estate, the mortgage holder (the bank or another lender) must typically record it with the recorder's office for the county where the real estate is located. To perfect security interests in cars or business assets, the holder of the security interest must typically record it with whatever statewide or local agency handles recordings under the Uniform Commercial Code (these are called "UCC recordings," and they are usually filed with the secretary of state or department of state).

Common Examples of Security Interests

Many everyday loans qualify as security interests, including:

• Mortgages. Called deeds of trust in some states, mortgages are loans to buy or refinance a house or other real estate. The real estate is collateral for the loan. If you fail to pay, the lender can foreclose.
• Home equity loans or HELOCs. You can borrow against the equity in your home to remodel your home, or pay for other things, such as college tuition or a car. No matter how you spend the money, the house is collateral for the loan. If you fail to pay, the lender can foreclose.
• Loans for cars, boats, tractors, motorcycles, or RVs. Here, the vehicle is the collateral. If you fail to pay, the lender can repossess it.
• Loans for business equipment, machines, or inventory. The lender can repossess the property you pledged as collateral if you don't repay the loan.
• Store charges with a security agreement. Almost all purchases on store credit cards are unsecured, as are major credit cards. Some stores, however, print on the credit card slip or other receipt that the store "retains a security interest in all hard goods (durable goods) purchased," meaning that if you don't pay the credit card bill, the store will have the right to take back the purchased items. If you didn't specifically sign a security agreement setting out repayment terms, debts like these are generally considered unsecured debts in bankruptcy. However, if the store makes you sign an actual security agreement setting out the amount financed, the interest rate, and the number of payments (the basics required under the Truth in Lending Act for installment payments) when you use the store's credit card, the debt might be secured. For example, if you buy building supplies on credit, the store

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