Bankruptcy & Secured Items

Bankruptcy does not discharge liens on secured items like cars bought with an auto loan.

Bankruptcy has a different effect on debts and property depending on whether the debt or property is secured or unsecured. A secured item of property is subject to a creditor's lien, and bankruptcy does not eliminate liens. Bankruptcy only discharges personal liability on debts. The lien also has an effect on whether the item of property may be exempt under state law.

Definition

A secured debt includes two separate legalities, which are the personal obligation and promise to repay the loan, and the lien granted in the secured property. The secured property is commonly referred to as the collateral. Auto loans, home mortgages and home equity lines of credit are the most common types of secured debts and secured property.

Exemption

When you file for Chapter 7 bankruptcy you have to include all of your non-exempt property as part of your bankruptcy estate. The bankruptcy trustee will attempt to raise money to pay off your creditors by selling your non-exempt property. Exemptions are determined according to state law. A secured item of property may or may not be exempt, but if it is, you must calculate your equity in the property in order to determine whether that property will be sold by the creditor. If your equity exceeds the exemption amount, then the trustee will sell the secured item, give you cash equal to the exemption amount and then use what's left over to pay your secured creditor on that piece of collateral. However, if your equity is less than the exemption amount, then you will not lose your property.

Debt Discharge

One of the great advantages of bankruptcy is the debt discharge that results as part of a Chapter 7 liquidation or after payment of a Chapter 13 debt repayment plan. The debt discharge means that you no longer have a legal obligation to repay any debts that existed as of the date you filed for bankruptcy. On a secured debt, this means you legally extinguish the personal liability component of the secured debt.

Lien Survival

Even though your personal liability on a secured debt may be discharged, the collateral is still at risk to the lender because bankruptcy does not discharge the lien component of the secured debt. The lien survives bankruptcy and the lender has the right to exercise the lien if you don't stay current on the secured debt payments. So, unless you want to lose your secured property to the lender, you still have to pay your secured debts after bankruptcy even if your personal liability on the debt has been discharged. Failure to pay risks forfeiture of the secured property.

References

• "The New Bankruptcy: Will It Work For You?"; Stephen Elias; 2009