How does bankruptcy treat something you bought—furniture, an appliance, or some electronics—when that thing is collateral on a debt?
In our last couple blog posts we compared how Chapter 7 “straight bankruptcy” and Chapter 13 “adjustment of debts” each deal with vehicles that are collateral on vehicle loans. Today let’s look at other personal property that you buy on credit where the creditor has the right to repossess the stuff if you don’t pay the debt.
Secured and Unsecured Debts
We first need to determine whether the creditor really has a right to repossess if you don’t pay.
That’s not always clear. For example, usually Visa and MasterCard purchases create unsecured debt. If you buy a $900 couch on a Visa card, you owe the $900 but Visa or your bank does not have a legal right to repossess the couch. It’s an unsecured debt.
But if you buy that couch on the store’s own credit card or through an old fashioned contract purchase often the fine print of your agreement will state that you are giving the store or financing company a “security interest” in the couch or anything else you buy. This gives that creditor a right to repossess whatever you buy until you pay off either the whole debt or else that part of the debt used to make that purchase. That’s a secured debt.
So the first thing your attorney will do is tell you whether something you bought is collateral on the debt or not. He or she will determine that by either just knowing from experience whether that particular creditor always requires purchasers to give a “security interest” or not. Or your attorney may need to review the creditor’s contract. Sometimes it takes a detailed analysis—such as when you’ve made a string of purchases with one creditor and made many payments over a span of time—to determine which if any of the purchased items have been paid off and which are still collateral on the debt.
Purchase Money Secured Debts
In certain in ways the law treats collateral purchased on credit different than collateral that you already own but then offer up as collateral. For now just be aware that today we are talking about the former—“purchase money” secured debts.
A bankruptcy discharge—the legal write-off of debts you receive in a successful case—writes off both unsecured debts and secured ones.
Unless you were involved in fraud or some other bad behavior in acquiring the debt, that’s the end of the story for an unsecured creditor. It can never chase you for that debt or chase anything you bought on that unsecured debt.
But it’s a different story for secured debts. Bankruptcy does not usually cut off a creditor’s right to repossess collateral. So, in the same way that discharging a vehicle loan still leaves its lender’s lien on the vehicle’s title, the furniture or appliance continues to have the store’s or financing company’s lien on it. And in the same way that a vehicle creditor can repossess the vehicle after a Chapter 7 case if you don’t pay the loan, a store or financing company can repossess a couch or other collateral on a secured debt if you don’t pay the debt after the Chapter 7 case is finished.
So here are your choices under a Chapter 7 case with personal property collateral, using as an example the couch bought for $900 that we mentioned earlier:
If you want to keep the couch, you can formally agree to pay for it by “reaffirming the debt,” meaning that you sign a document that excludes that debt on the couch from the discharge of your other debts. You will continue being legally liable on that debt, and the couch will be yours free and clear when you pay off the debt, just as if you hadn’t filed the Chapter 7 case. This may give you an early start on rebuilding your credit, but if in the future you can’t make the payments the couch could still be repossessed and you would still owe the rest of the debt.
Under some circumstances you may be able to keep the couch by reaffirming the debt for less than the full balance owed. This may especially be the case if the couch is worth much less than the debt. So if the couch has depreciated to being worth only $300 and you still owe $800, you may be able to reaffirm for an amount in between those amounts and hopefully close to $300. The creditor recognizes that if you surrendered the couch it wouldn’t get more than $300, plus would have to pay repossession and selling expenses.
If you don’t want the couch or don’t want to pay for it, you can surrender it to the creditor, and then discharge the debt. You would owe nothing further, again except in the rare situation that you incurred the debt through fraud or similar bad behavior.
If you want the couch but don’t want to pay for it, you can simply not reaffirm the debt and see what happens. Without a reaffirmation the debt would be discharged and you would owe nothing more. There is a chance that the creditor would decide that, after accounting for the repossession and selling costs the couch is just not worth repossessing. In the right circumstances this may be a gamble worth trying.
Our next blog post will show how collateral on secured debts can be treated better under Chapter 13, but with its own risks.