Introduction

Dreading that climax of all human ills, The inflammation of one's weekly bills.
-- George Gordon, Lord Byron, English poet, 1788-1824

A debt is an obligation to pay someone money. It may be a large obligation, such as a home mortgage or monthly rent, or a small obligation, like a newspaper or magazine bill. If you don't pay, you often suffer some consequences. At the serious end of the scale, if you don't pay your mortgage or rent, your house may be foreclosed on or you may be evicted. At the minor inconvenience end, if you overlook paying a subscription, it will be canceled and you will be sent letters demanding that you pay for copies you've already received.

The purpose of this chapter is to help you figure out the kinds of debts you have. You may think of your debts in several different ways, such as:

• Debts to people you know, such as a loan from your Aunt Muriel or a bill you owe Angelo, the owner of the local grocery store -- versus debts you owe to impersonal creditors, for example, a credit card company.
• Your regular monthly obligations, for instance, rent, phone bill, or gas bill -- versus debts you pay only when you buy something on credit.
• Debts for goods or services you are currently receiving, for example, a newspaper subscription or credit card bill -- versus debts to repay money borrowed many years ago, such as a student loan.
• Debts you'd rather not pay and wonder if you really owe, such as back taxes -- versus debts you don't have any reasonable grounds to object to paying, for example, your utility bill.

Groupings such as these may help you decide how and in what order you will pay your bills. Legally, however, these categories are irrelevant. Instead, the law puts debts into two primary groups: secured and unsecured. To understand your debts and to intelligently decide what to do about each one, you must understand the difference. You must also understand that the consequences of not paying a secured debt differ tremendously from not paying an unsecured debt. (These consequences are explained in Chapter 8.)

The importance of correctly distinguishing between secured and unsecured debts can't be overemphasized. If, after reading this chapter, you are still not sure you can tell a secured debt from an unsecured debt, reread the material.

Secured Debts

A secured debt means that a specific item of property (called "collateral") guarantees payment of the debt. If you don't pay, the creditor is entitled to take the collateral. If you've ever had property, such as a car, repossessed when you failed to make a loan payment, you already know how secured debts work.

These debts should be your highest priority. If you don't pay them, you will lose the collateral backing them up. Even if you don't hear from these creditors, don't assume they won't collect the debt. Because secured collectors have such a powerful weapon (they can seize the collateral if you stop making payments), they don't need to hound you the way that collectors with lower-priority debts do.

There are two types of secured debts: those you agree to and those created without your consent.

Security Interests: Liens You Agree To

A security interest is an agreement in which you specify precisely what collateral the creditor can take if you default. A security interest also creates a "lien": the creditor's legal right to take the collateral if you don't pay. There are two kinds of security interests:

Purchase money. With a purchase money security interest, you pledge as collateral the property you buy using the loan proceeds. This is usually a home, motor vehicle, piece of furniture, large appliance, or electronic equipment.

Nonpurchase money. With a nonpurchase money security interest, you simply borrow a sum of money and pledge some property you already own as collateral. Personal loans from a bank and home equity loans are typical nonpurchase money agreements.

Some common examples of security interests -- both purchase money and nonpurchase money -- include the following:

• Mortgages (sometimes called deeds of trust), which are loans to buy or refinance a house or other real estate. The house or other real estate is collateral for the loan. If you fail to pay, the lender can foreclose on the house or property.
• Home equity lines of credit or loans (sometimes called HELOCs or second mortgages) from banks or finance companies, such as loans to do work on your house. The house or other real estate is collateral for the loan. If you fail to pay, the lender can foreclose on the house or property.
• Loans for cars, vans, trucks, boats, tractors, motorcycles, RVs, for which the vehicle is the collateral. If you fail to pay, the lender can repossess the vehicle.
• Store charges with a security agreement -- for example, when you buy furniture or a major appliance using a store credit card. If you don't pay back the loan, the seller can take the property. Only a few department stores use security agreements. Most store purchases are unsecured (discussed below).
• Personal loans from finance companies. Often your personal property, such as your furniture or electronics equipment, is pledged as collateral.

Mortgages, vehicle loans, and store charges with a security agreement are purchase money security interests. Home equity loans and personal loans from finance companies are nonpurchase money security interests.

Federal law limits the ability of certain creditors to take security interests in household goods (for example, appliances, a television, kitchenware, or personal effects).

These creditors cannot take a security interest in household goods unless it is a purchase money security interest, or unless they take possession of the goods when they make the loan.

Nonconsensual Liens: Liens Created Without Your Consent

In some circumstances, a creditor can get a lien on your property without your consent. These secured debts are called nonconsensual liens. A creditor with a nonconsensual lien claims you owe money and, to secure payment, places a lien on your property. To get paid, the creditor may be able to force the sale of the property. This is called a foreclosure. In practice, however, few creditors holding nonconsensual liens foreclose on property because of the time and expense involved. Instead, creditors generally wait until you sell the property to get paid.

There are three major types of nonconsensual liens:

• Judicial liens. A judicial lien can be placed on your real property only after somebody sues you and wins a money judgment against you. In most states, the judgment creditor then must record (file) the judgment with the local land records office. The recorded judgment creates a lien on your real property. In a few states, a judgment entered against you by a court automatically creates a lien on the real property you own in that county -- that is, the judgment creditor doesn't have to record the judgment to get the lien. In some states, judicial liens apply to personal property as well.
• Statutory liens. Some liens are created automatically by law. For example, if you hire someone to work on your house, and you don't pay the contractor or supplier of materials (or you pay the contractor, who fails to pay the supplier), whoever doesn't get paid can place a lien on your home, without going to court. This is called a mechanic's lien or a materialman's lien. In some states, a homeowners' association can do this as well, if you don't pay your association dues.
• Tax liens. Federal, state, and local governments have the authority to place liens on your property if you owe delinquent taxes.

Unsecured Debts

An unsecured debt is one for which no specific item of property guarantees payment of the debt. In other words, an unsecured debt is not secured by collateral. For example, when you charge clothing on your bank credit card, you don't sign a security agreement specifying that the clothing is collateral for your repayment. With no collateral, the bank has nothing to take if you don't pay. This leaves the bank that issued the credit card only one option if you don't pay voluntarily: to sue you, get a judgment for the money you owe, and try to collect on it. To try to collect on the judgment, the bank can go after a portion of your wages, your deposit accounts, and other property that can be taken under your state's laws to satisfy money judgments. (See Chapter 14.)

Most debts that people incur are unsecured. Common ones include:

• credit card cash advances
• credit card purchases
• gasoline and department store charges, unless you sign a security agreement
• loans from friends and relatives
• student loans
• alimony and child support
• medical and dental bills
• accountants' and lawyers' bills
• rent
• utility bills
• church or synagogue dues
• health club dues, and
• union dues.

Not all unsecured debts are created equal. Collectors of some unsecured debts such as student loans and unpaid child support are allowed to use more aggressive collection tactics than the typical unsecured creditor. (See Chapters 14 and 15 for information on these types of debts.)