This post is a “cornerstone post”, which is what I like to call posts that discuss a basic area of bankruptcy law, and that might be linked or referred to in other blog posts. As a result, it might be less interesting, but more informative than the “topical” posts on the blog. Enjoy!
What are the different kinds of debt?
If you’re considering bankruptcy, or assessing the health of your current financial situation, you may think about the debt you have in categories such as: doctor’s bills, credit cards, personal loans, title loans, check advance loans, car loans, and mortgages, etc. You are not wrong to look at your bills this way, but it is important to realize that the bankruptcy court may not categorize them the same way you do.
According to bankruptcy law, some of your debts would be grouped together in ways that don’t make sense, such as car loans and Mortgages. Likewise, some debts you think are alike may be treated differently by the bankruptcy court, such as a car title loan, and a payday advance. In bankruptcy, there are really only two different classifications of debt: Secured and Unsecured. Whether you owe money to a reputable hospital, or a shady payday loan center, the only thing the bankruptcy court cares about is whether the debt is tied to an asset. Or to put it another way, is it ‘backed up by collateral’? If it is, it is a secured debt. If it is not, it is an unsecured debt. Very simple, no?
Examples of secured debts and unsecured debts.
Secured Debts: Mortgages and HELOCs, Liens (for example: judgment and tax liens), Car Loans Payday loans
Unsecured Debts: Medical Bills, Credit Cards, Bank Fees, Purchase Money Security Interests (“PMSI” -see below for greater detail)
How does the type of debt I have affect my bankruptcy?
The types of debt you owe has a huge effect on your bankruptcy, it can affect your choice between chapter 7 bankruptcy, and chapter 13 bankruptcy, your chapter 13 plan payments, your liquidation analysis, exemptions, equity, and whether you’ll need to sign a reaffirmation agreement.
The way to understand how they affect your bankruptcy is to imagine what rights your creditor has. If your creditor has an unsecured debt, that means that they have a promise from you to pay them back, and nothing more. If you do not pay, they cannot come to your house and take something of yours and sell it. (Unless, of course, they turn their unsecured debt into a secured debt by getting a judgment lien, but that is a topic for another post). On the other hand, if your creditor has a secured debt, that means that they have both a promise to pay, and some collateral that they can take back and sell to get their money if you default on the debt.
If, for example, you enter a chapter 7 bankruptcy, your estate is liquidated by the trustee. In practicality, this usually does not mean that you’ll lose any of your assets because they are generally covered by exemptions. But in theory, what happens is that the trustee takes your stuff and sells it. Now if you have a car loan, some medical bills, and two credit cards, and the only asset you have is a car, then the only creditor that is going to receive a distribution from the trustee is the car financer, because they have a secured debt, which means that the money from the sale of the car belongs to them.