What Happens to Secured Debts in Bankruptcy

Debts may be secured or unsecured and when a debtor files for bankruptcy, these classifications matter. What difference does it make whether a debt is secured or unsecured?

What happens to each type of debt when a debtor files for bankruptcy? These are the questions that our basic guide will answer.

Secured Debt Defined

A secured debt is a debt that a debtor makes with a promise to pay the creditor with certain properties or the proceeds of the sale of this property in case he is unable to pay what is owed. The debt may have been made as a loan transaction secured by a house or a vehicle as collateral. During bankruptcy, a secured creditor gets higher priority over an unsecured creditor -- meaning his claim takes precedence over that of an unsecured creditor. When payments from the proceeds of a debtor’s estate are made, he gets paid ahead of the unsecured creditor. But this priority status is not something automatic, but must be “perfected,” through submission of certain requirements by the creditor.

Lien on Debtor’s Property

A creditor that has filed a notice of claim on certain of the debtor’s properties might also become a secured creditor. Home and car financing are typical secured debts. Tax due to the IRS might also be secured if the IRS filed a lien against the debtor’s property. These debts that are protected by collateral or real property are not erased under either a Chapter 7 or Chapter 13 bankruptcy filing. How the secured debts are settled will depend on the bankruptcy filing, and the state where the filing was made, among other factors. For example, under a Chapter 7, if you are behind on your car loan payments, you might have to let the car loan financer take the car back; under Chapter 13, you might be able to keep it by negotiating to continue paying the arrears with a promise to do it regularly.

Because most unsecured debts are cancelled under a Chapter 7, it might be tempting to convert a secured debt to an unsecured debt. Be aware that the court is on lookout for fraudulent or preferential transfers, which could complicate or invalidate a debtor’s filing, or worse put him in jail.


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