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Dealing with secured debts in Chapter 7
When a debt is secured, the creditor has rights in the security (or collateral) in addition to the rights against the debtor. The debtor's personal liability may be discharged in Chapter 7 while lien rights in the collateral pass through bankruptcy unaffected unless they are avoided or stripped down. More on avoiding liens. When the lien cannot be avoided, the debtor gets choices about how to provide for the creditor's rights in the collateral.
Long term secured debt like mortgages pass through the bankruptcy unaffected by the discharge. Most creditors secured in real property are happy to continue receiving payments on the debt, so long as you are current. More on home mortgages after bankruptcy. See Chapter 13 for using that chapter to cure defaults in long term secured debts.
You've got choices:
redeem, reaffirm, or surrender
- Redemption means that you pay the secured creditor the present value of the asset that is the collateral for the debt in a single cash payment. Upon payment, the asset is yours, free of the secured debt. The balance of the debt is treated as an unsecured debt in the bankruptcy and discharged with your other debts.
- Reaffirmation is an agreement to waive the discharge as to the reaffirmed debt and to pay the debt according to the terms of the original agreement. The reaffirmed debt is legally enforceable if you breach (stop paying) later on, and the creditor retains the security interest in the asset until the debt is paid.
- Surrendering the collateral renders the debt an unsecured debt in the bankruptcy. The creditor can sell the asset to recover part of the claim. Even if the asset isn't worth what was owed on it, the unpaid balance is discharged in the bankruptcy.
Among the documents filed in a Chapter 7 case is a statement of intentions which advises all parties what the debtor proposes to do with respect to those assets subject to liens. The statement of intentions can be amended to show a different treatment, if the debtor changes his mind.
There's more: the unwritten choice
The other option, not included in the bankruptcy code, is to do nothing with respect to the lien. Prior to the amendments to the Bankruptcy Code, in some jurisdictions, such as California, if you continue to make the payments on the debt secured by a car, for example, the creditor cannot repossess the car.
The bankrutpcy amendments of 2005 have introduced even more uncertainty: the provision that said that bankruptcy filing alone could not be a contract default was eliminated. State law probably now controls on whether a contract that is current on payments is breached by merely the bankruptcy filing.
Another variable is that some lenders are choosing to take no action to compell reaffirmation, content to collect the payments without a reaffirmed loan contract.
If the asset has a low value relative to the cost of repossessing it (such as used computers, major appliances, automobile tires) the debtor can simply decline to redeem, reaffirm or surrender and wait to see if the creditor will take action to recover the collateral after the bankruptcy. In our experience, creditors threaten but do not pursue this kind of collateral after the bankruptcy.
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