Most people have a loan secured by property, such as a mortgage or a car loan. These debts, called "secured debts," can be tricky in Chapter 7 bankruptcy. Although you can wipe out or "discharge" a secured loan in Chapter 7 bankruptcy, you'll lose the property you purchased if you don't pay for it after bankruptcy. Here's why.
When taking out a secured loan, you agree the purchased property will be collateral, creating a voluntary "lien." The lien lets the creditor recover the property if you don't pay—even if you file for Chapter 7 bankruptcy. Filers don't always lose secured property in Chapter 7, but keeping it will depend on the following:
We explain both Chapter 7 secured property approaches below and briefly cover options available in Chapter 13. However, keep in mind this article addresses voluntary liens only. You can learn about voluntary and involuntary liens in What Happens to Liens in Chapter 7 Bankruptcy?
If you're making payments on an expensive property—such as a home, car, diamond ring, computer, or couch—you've likely agreed that the property will serve as collateral and the lender can sell the collateral if you don't pay as promised. For instance, the lender might repossess a car or foreclose on a home if you fall behind on the payment.
Whether the lender must go to court before selling the property will depend on your state's laws. Also, some states will give the lender a "deficiency" judgment for the remaining balance if the sale brings less than the amount owed.
You can eliminate your responsibility to pay a mortgage, car payment, or another secured debt in Chapter 7 bankruptcy. However, filing for bankruptcy doesn't take away a lender's lien rights to reclaim the property. Why? Because a secured debt has two parts:
In some situations, you can ask the bankruptcy court to remove the lien as part of your bankruptcy case. For instance, the bankruptcy court might remove an involuntary property lien placed by a state court after trial if the lien interferes with a bankruptcy exemption.
If you have a debt secured by property and you file for Chapter 7 bankruptcy, here are your options, assuming you meet all requirements:
If you're wondering what it means to protect equity with a bankruptcy exemption or want more details about redeeming property in Chapter 7, keep reading.
If you're behind on a secured debt payment, like a mortgage or car payment, filing for Chapter 7 bankruptcy won't help you keep the property. Why? Because Chapter 7 doesn't have a mechanism to catch up on payment arrearages.
If you can't make arrangements to bring your payments current, you'll likely lose the property after your case ends. You could lose your asset even sooner if the court lifts the automatic stay to allow for foreclosure or repossession.
Because there's no way to force a lender to work with you in Chapter 7, if you want to keep secured property, ensure you're current on payments and can protect all property equity before filing.
You can protect some property when you file for bankruptcy, but the amount you can keep will depend on your state's bankruptcy exemptions. If you owe more on a secured loan than the property securing the debt is worth, you don't have equity and can skip this step. However, suppose you can't protect all of a property's equity. In that case, the Chapter 7 bankruptcy trustee assigned to the case would sell it for your creditors' benefit.
Here's how it works.
Example. You owe $3,000 on a car worth $6,000, leaving you with $3,000 in equity. Your state's vehicle exemption will let you protect $1,000. In this case, the trustee would sell the car and pay your secured creditor the $3,000 you owe. You'd receive the $1,000 exemption amount. The remaining $2,000 would go to unsecured creditors, minus any costs of sale and the trustee's commission.
Yes. If you're behind and want to keep the property, Chapter 13 bankruptcy is probably the better choice. In Chapter 13, you can make up missed payments over time using the Chapter 13 repayment plan. However, keep in mind that you'll need to be able to afford the regular monthly payment and meet other Chapter 13 payment plan requirements, too.
When you redeem property in Chapter 7 bankruptcy, you can satisfy the loan by paying the value of the property in one lump sum payment. If you and the creditor disagree about how much the property's worth, the court will decide at a "valuation" hearing. The judge will extinguish your obligation to the creditor after you pay the agreed-upon lump sum amount.
If you're wondering how bankruptcy exemptions come into play here, the simple answer is they don't. Filers redeem property in Chapter 7 bankruptcy only when property equity doesn't exist because one of the requirements is that you owe more than the property is worth.
You can redeem property in Chapter 7 bankruptcy only if you meet all of the following conditions:
A Chapter 7 property redemption is often a good option if your debt balance exceeds the property's value. Why? Because if you redeem the property in bankruptcy, the creditor must accept the item's value as payment in full, even if you owe significantly more.
The main drawback to redemption is most debtors can't afford to pay the property's value in a single payment. Some companies specialize in lending to people seeking to redeem property, so a loan might be an option. Or you might be able to get the money from a friend or relative.
Chapter 13 offers ways to reduce the amount owed on secured property, but bankruptcy practitioners refer to these procedures by different names. You'll use a "cramdown" to reduce what you owe on personal property, like your car. You can even use a Chapter 13 cramdown on investment real estate.
A "lien strip" is used to pay significantly less on a wholly unsecured mortgage on your residence. You'll find more information about reducing your residential home mortgage in Chapter 13 in Keep Your House in Chapter 13 Bankruptcy.
Did you know Nolo has been making the law easy for over fifty years? It's true—and we want to ensure you find what you need. Below you'll find more articles explaining how bankruptcy works. And don't forget that our bankruptcy homepage is the best place to start if you have other questions!
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We wholeheartedly encourage research and learning, but online articles can't address all bankruptcy issues or the facts of your case. The best way to protect your assets in bankruptcy is by hiring a local bankruptcy lawyer.