Bankruptcy 101: Secured vs. Unsecured Debt

Time to go to school again. This lesson can be very short if you’re just trying to understand what Secured and Unsecured Debt are as well as what the difference is between the two. Here goes:

Secured debt is a debt that is backed by some type of collateral. This collateral reduces the risk associated with lending because, if the loan is not paid back, the collateral can be taken instead. Basically, you give something to borrow something else and if you don’t pay, you lose that thing you gave instead as a type of payment. For example, you borrow $10,000 to start a business and you put your car as collateral. If you don’t pay the $10,000 back or miss a payment, then the bank will take your car.

Unsecured debt is debt that is NOT backed by some type of collateral. So, you don’t give something instead even if you don’t pay back the loan. To get back what you owed, the bank or person has to try and get it from you in other ways. For example, if you borrow $10,000 and you can’t pay it back, then the bank has to sue you to get you to pay the money back.

The biggest reason to understand the key distinction is because if you call me with plans to file a Chapter 7 Bankruptcy, I might tell you that because of your secured debt (e.g. house mortgage or car payments), you probably won’t be eligible for a Chapter 7 so a Chapter 13 is the route to go.
Now you know a mortgage or car payment is a secured debt because if you don’t make the payments, you lose the house or car. The most common type of unsecured debt is credit card debt and hospital bills. If you stop making payments, for example, Bank of America isn’t going to come take your car because they can’t. They CAN cancel the card and sue you to recover the debt. Also, with hospital bills, a surgeon isn’t going to come to your house and take back the artificial knee he put in a year ago; however, the surgeon (or the hospital on his behalf) CAN sue you to recover the unpaid bills. 

Remember, Chapter 7 Bankruptcy filings are total liquidations; you keep what you can under the law and everything else is given up. If you have something you cannot give up, such as a house or car, you might be better suited to file a Chapter 13. Call me (703-260-6060) and let’s talk about your options.