Filing for bankruptcy involves disclosing your debts, or “creditor claims,” on official bankruptcy paperwork. But as easy as that might sound, classifying claims can get a bit tricky.
First, you’ll list the debt as either a secured or unsecured claim. Then, you’ll divide the unsecured claims into priority and nonpriority unsecured claims. In this article, you’ll learn how to properly label each debt and find out what will happen to it in bankruptcy.
A bankruptcy case gets started after you complete and file official bankruptcy forms. The cover document, called the petition, is where you’ll disclose identifying information, such as your name, address, and the bankruptcy chapter you’re filing. You’ll provide details about your income, creditor claims (debts), and assets on forms called schedules.
Creditor claims will appear on one of two schedules:
A creditor with a secured claim in bankruptcy has two things: a debt that you owe and a lien (also called a security interest) on a piece of property you own. If you don’t pay according to the terms of your contract, the lien allows the lender to recover the property, sell it at auction, and apply the proceeds to the account balance. For instance, a mortgage lender with a lien can recover real estate in a foreclosure action, and a vehicle loan lender with a lien can recover a car through repossession.
Secured claims are often voluntary. For instance, if you agree to pledge an asset as collateral for the loan (a common practice when buying a house or car), you voluntarily give the creditor a security interest in your property.
Creditors can also obtain an involuntary lien against your property without your consent. For instance, a credit card company can get an involuntary lien after suing you in a collection lawsuit and winning a money judgment. When you fall behind on your taxes, statutory law gives the IRS the right to a tax lien against your property.
Common examples of secured bankruptcy claims include:
You’ll list all secured claims on Schedule D: Creditors Who Hold Claims Secured By Property.
A creditor with a secured claim is in a good position. A bankruptcy discharge (the order that wipes out debt) won’t get rid of a lien on your property. It only eliminates your liability to pay the debt.
Since the lien remains, the creditor can still foreclose or repossess the property if the loan doesn’t get paid. So if you file for bankruptcy and want to keep property securing a loan, you’ll have to continue making payments to the lender until you pay off the debt.
However, if there is significant equity in a house or car, a Chapter 7 trustee will likely sell it. But, because of the lien, the trustee must get enough to pay off the loan, return any exemption amount to you (the amount of equity you’re allowed to protect), and use the remaining funds to pay off creditors. If there isn’t enough equity to pay something meaningful to creditors, the trustee won’t sell the property. (You can find out more about how this works by reading Will I Lose My Home If I File for Chapter 7 Bankruptcy?)
If a property you’d like to keep has significant equity, a Chapter 13 case will likely be a better option. But you’ll have to have enough income to pay a hefty monthly payment for three- to five-years (you must pay the value of the nonexempt equity in the plan). (Learn more by reading Keep Your House With Chapter 13 Bankruptcy.)
Eliminating Liens in Bankruptcy You can eliminate certain types of property liens in bankruptcy. For instance, you might be able to ask the court to:
(Find out more about filing adversary proceedings in bankruptcy.)
- get rid of a judgment lien that impairs your bankruptcy exemptions, or
- wipe out a wholly unsecured junior lien from your property in Chapter 13 bankruptcy.
A creditor with an unsecured claim doesn’t have a lien. There are two types of unsecured claims:
(For a comprehensive list of unsecured claims, see What Is an Unsecured Debt?)
The bankruptcy discharge will eliminate most types of nonpriority, unsecured claims, but not all. Some of the most common nonpriority unsecured claims you can discharge in bankruptcy include:
Although student loans are unsecured debts, you can’t discharge them unless you can prove that it would be an undue hardship to pay them (which is a difficult standard to prove).
(See Student Loans and Bankruptcy for more information.)
Priority unsecured debts aren’t dischargeable and receive special treatment. Priority creditors get paid before other creditors in bankruptcy.
The following are some of the most common types of priority claims:
Because you can’t wipe out priority debts in Chapter 7 bankruptcy, you’ll be responsible for paying any balance that remains after your Chapter 7 case (the bankruptcy trustee might sell some of your property and apply the funds to the debt).
If you file for Chapter 13 bankruptcy, you’ll have to pay off priority unsecured debts in full through your three- to five-year repayment plan.
You’ll list unsecured claims on Schedule E/F: Creditors Who Have Unsecured Claims.