Chapter 7 and Chapter 13–Encumbered Assets
Sept. 28, 2015
Some of the assets you may want to protect in a bankruptcy case are those that are security for debts.
Collateral and Other Security on Secured Debts
Everything you own is either legally encumbered by a debt or is yours free and clear of any debt.
Possessions which are encumbered by a debt can be encumbered voluntarily, such as when you buy on credit. You buy a vehicle and give the vehicle loan creditor a lien on the title. You buy a home and the mortgage lender gets a mortgage on the home. You buy an appliance and give back a security interest in what you bought to the store or finance company.
Or you can already own something and you borrow money on it, like a second mortgage, or when you take out a personal loan and provide collateral for it.
Possessions can also be encumbered involuntarily. An income tax lien on everything you own and a judgment lien on the title of your home are examples.
You may want to keep your possessions that are encumbered voluntarily or involuntarily by a debt, or you may not. How Chapter 7 “straight bankruptcy” or Chapter 13 “adjustment of debts” each helps you do so can be the main reason to choose one or the other.
Chapter 7 vs. 13 on Protecting Collateral and Other Security
If you are current on a debt that is securing something you own and want to keep, then you can likely keep that possession by filing a Chapter 7 case, getting rid of most or all of your other debts so that you can better afford to pay that secured debt. Your vehicle or home or appliance should be much easier to pay for once you unburden yourself of other debts. You will likely need to exclude that secured debt from the “discharge”—legal write-off—of your other debts by “reaffirming” the debt, by legally confirming that you will continue being liable on that debt.
If you are not current on your secured debt and want to keep the possession that is securing it, you may need the extra possessions of Chapter 13:
With a vehicle loan you would either have many months or even a couple years to catch up on missed payments, or if the loan is more than two and a half year old you may never need to catch up and may even be able to reduce the monthly payments and how much you have to pay before your vehicle is free and clear.
With a home mortgage you would have up to 5 years to catch up. If you’re behind on your property taxes you would have that much time to catch up on it. If you owe more on the first mortgage than your home is worth you could likely “strip” a second mortgage off your title, allowing you to stop making payments and pay little or nothing on that balance. Involuntary liens against your home like income tax liens may be turned into unsecured ones or partially unsecured ones and so be paid little or sometimes even nothing before they are released from your title.
With an appliance loan, if it was more than a year old you would likely not need to catch up, would likely be able to reduce both the monthly payment and the total amount paid before the appliance was yours free and clear.
Chapter 7 vs. 13 on Surrendering Collateral and Other Security
When you surrender something you own that is encumbered by a debt often you will continue to owe that debt, and often owe a lot. When you surrender a vehicle you will likely be sued for the “deficiency balance,” the amount still owed on the loan after the creditor adds up all the late fees, repossession and selling costs, and credits the account the relatively small amount the creditor sold the vehicle for at an auto auction. When you give your home to your mortgage lender, you may or may not owe that lender depending on the type of mortgage and your state’s laws about it. But you will very likely continue owing a second or third mortgage and most of the other debts on the home’s title. When you surrender an appliance, like a vehicle you will likely still owe a substantial amount of the debt.
Filing either a Chapter 7 or Chapter 13 case will almost always discharge any debts from such surrenders.
Under Chapter 7, the debt will be completely gone without you having to pay anything on them, and in a matter of only 3 or 4 months, except in two relatively rare scenarios.
First, if you defrauded the creditor when you first became liable on the debt, that creditor may be able to challenge your right to write off the debt. That very seldom happens, and you’ll know quickly whether such a challenge would be raised.
Second, if everything that you own is not protected by property “exemptions,” the Chapter 7 trustee might take something you own, sell it and pay a small part of your debts, including the one on the surrendered collateral. Again, that’s quite rare.
Under Chapter 13 the debt remaining after you surrender the collateral would be treated as an unsecured one and may need to be paid in part during your 3-to-5 year payment plan. But it often does not increase what you pay overall, because it just reduced what your other creditors receive.