Although you may have heard that bankruptcy can help eliminate or reduce debts, you may not be sure how it works. If you are among the many Americans struggling to pay off debt, it would be helpful to know how a bankruptcy might be of assistance.
In general, there are two kinds of debt: secured and unsecured. Secured debt is a financial obligation where collateral is promised in exchange for credit. This type of debt includes car loans, mortgages and certain credit card accounts. When you default on secured debt the creditor has the option of repossessing, or foreclosing upon, the collateral and reselling it to attempt to pay off what you owe.
Unsecured debts, as the term suggests, are not secured by collateral, and include credit cards, medical bills, personal loans and old utility bills. If you default on unsecured debt, repossession or foreclosure is not an immediate option. The creditor may instead file a lawsuit to collect the delinquent amount.
How bankruptcy can help
The fate of your debts may depend upon the type of bankruptcy you file, Chapter 7 or Chapter 13. Chapter 7 bankruptcy ordinarily discharges unsecured debt, resulting in a court order declaring that the debt is no longer owed. Secured debts are treated differently.
Although Chapter 7 can clear you of your obligation to repay secured debts, it does not eliminate the right of creditors to repossess or foreclose upon the collateral. As a result, if you want to retain the collateral it is necessary to continue to make installment payments. The good news is that keeping up with mortgage and car payments may be easier once credit cards and other unsecured debts are eliminated.
Debts may be treated differently under Chapter 13, which requires repaying certain obligations over three to five years. However, the law does not usually require that all debts be repaid. In most Chapter 13 cases unsecured creditors receive only a small portion of the debt they are owed, with the balance being discharged (erased) by court order upon completion of the payment plan.
A particular advantage of Chapter 13 is that it can help if you have fallen behind with payments on secured debts. For example, a Chapter 13 plan allows for the repayment of mortgage arrears or outstanding real estate taxes in monthly payments over three to five years. During the plan period creditors are prohibited from resuming foreclosure proceedings or repossessing the collateral as long as post-petition payments (after bankruptcy mortgage payments, for example) are continued.
A Chapter 13 bankruptcy can also be helpful with “priority” debts, such as income taxes, which may not be dischargeable under Chapter 7. Priority debts can often be more easily handled through Chapter 13, which prevents the IRS and other taxing authorities from garnishing wages in favor of full or partial repayment through the Chapter 13 plan.
Depending on your personal situation, one type of bankruptcy may be more advantageous than another. Since choosing the right bankruptcy chapter can mean the difference between success and failure, it is important to first consult with experienced bankruptcy attorney. Attorneys Vincent Rubino, Esq., and J. Zac Christman, Esq. have represented over 5,000 financially distressed people and families over the last 25 years and can show you the best way to regain financial solvency, even if a bankruptcy filing is not appropriate.