There are two kinds of debt: secured and unsecured. A debt is secured when the creditor/lender can recover a specified asset from the debtor/borrower if the borrower does not repay the loan on time. A car loan is an example. With unsecured debt, a borrower does not have to give collateral to receive the loan or services. One example is medical bills. If a debtor has doctor bills when they file bankruptcy, the doctor/creditor will not get paid and there is nothing they can do about.
However, the situation is very different when a debt is secured. Examples of secured debt are home mortgages and car loans. If a debtor gets behind on their home mortgage, the creditor can foreclose on that house by filing a lawsuit against the debtor.
A person with secured debt who files Chapter 7 bankruptcy has three options for resolving the debt. Those three choices are:
If debtor has a secured loan for a truck they cannot afford, they can surrender, or return, the truck to the creditor after filing bankruptcy. Doing so makes it as if the secured loan was never made. It does not matter if the debtor was behind on their installment payments or not. If they do not wish or cannot afford to continue paying the loan, the debtor can surrender the item to the creditor who loaned them the money to buy it in the first place, and the debt is discharged.
To redeem a secured debt, a debtor makes one lump sum payment to the creditor in order to keep the item in question. The experienced bankruptcy lawyers at Morgan & Morgan would negotiate with that creditor for the best possible price for the item. Because there are laws governing how much money a person pursuing bankruptcy can have when they file, and statutes dictating how valuable assets they own can be when they file, we work closely with our clients to determine if redeeming is a viable option for secured debt or not.
Reaffirmation, the third option, is by far the most popular. When a debtor reaffirms a secured debt, they sign a contract with the creditor stating that despite filing bankruptcy, they wish to keep the secured item and continue paying the loan as if they had not filed bankruptcy. They keep paying on the debt under the same conditions as their original contract.
Under the U.S. Bankruptcy Code, a debtor has to be current on their payments in order to request a reaffirmation. In other words, if they have missed some payments along the way before filing bankruptcy, a debtor can’t request a reaffirmation of secured debt.
If, for whatever reason, a secured debt cannot be reaffirmed, a debtor must either redeem or surrender the collateral. They cannot simply keep the asset without making some type of written payment arrangement with the creditor.
As bankruptcy attorneys, it is our job to ensure our clients understand what can happen to their secured and unsecured debts if a Chapter 7 bankruptcy is filed.