Power Over Your Secured Creditors in Chapter 7

Posted by Kevin on May 16, 2013 under Bankruptcy Blog | Be the First to Comment

Secured Debts

A secured debt is usually one in which your agreement to pay a debt is backed up with some collateral. If you don’t pay, the creditor can take possession and ownership of that collateral.  So, a mortgage holder can foreclose on your home, a vehicle lender can repossess your vehicle, and the appliance store can haul away your washer and dryer.

But for the creditor to have rights to your collateral—for the debt to be truly “secured”—the creditor needs first to have gone through the appropriate legal steps to tie the collateral to the debt.

Besides secured debts in which you voluntarily gave the creditor rights to the collateral, there are many kinds of secured debts in which the creditor got those rights by operation of law. This happens without your consent, sometimes even without your knowledge, often as part of the debt collection process. An example is an IRS tax lien recorded against your real estate and/or personal property for non-payment of income taxes.

Power Provided by Chapter 7

A Chapter 7 case can help with both voluntary and involuntary secured debts. It will 1) temporarily or permanently prevent your creditor from taking your collateral; 2) help you keep the collateral; and 3) if you want, enable you to surrender the collateral to the creditor without economically hurting yourself.

Power # 1: Stop the Creditor from Taking the Collateral

The moment your Chapter 7 case is filed, all your secured creditors are immediately stopped from taking possession of your collateral. This is the same power that stops all collection activity by all your creditors again you and your property. You may hear this referred to as the “automatic stay.”

Very importantly, not only does the “automatic stay” stop secured creditors from chasing previously agreed to collateral, also stops unsecured creditors from becoming secured ones, such as by stopping the IRS from getting a tax lien. Since secured creditors have tremendously more leverage, inside and outside of bankruptcy, this is a very helpful power that bankruptcy gains for you.

Power # 2: Keep the Collateral

Whether the collateral on a secured debt is your home, vehicle, appliances, or everything you own (as with an IRS tax lien), if you want to keep the collateral or whatever is included in a lien, bankruptcy can help in a variety of ways, including:

• If you are current on a secured debt and want to keep the collateral—such as with a vehicle loan—you can virtually always do so. . This is also a good way for you to get a head start on rebuilding your credit.
• If you are not current on your payments, you will generally be given a limited amount of time to bring the account current.
• In some situations, the loan terms can be changed to waive payment of any missed payments, to lower the interest rate, and perhaps even lower the balance.
• Select kinds of secured debts—for example, judgment liens on your home—can be “avoided”—stripped off your home title.

Power # 3: Dump the Collateral

Outside of bankruptcy, simply surrendering collateral to the creditor because you do not need or want it any longer, or just can’t afford to pay for it, is often not an economically sensible option. That is because you can end up still owing much of the debt after the creditor sells the collateral for substantially less than the amount of the debt, adds all of its sale costs to the debt, and then sues you for the remaining “deficiency balance.”

And if instead the creditor just forgives that balance, in some situations you can be hit with a serious income tax obligation. The amount forgiven may be considered “cancelation of debt income” upon which you may be required to pay income taxes.

Chapter 7 solves both of these problems. Except in very unusual situations, it would discharge (permanently write off) any “deficiency balance” after the surrender of any collateral. And the discharge of debts in bankruptcy is not considered “cancellation of debt income,” so you don’t have the risk of it is being taxed. As a result, you can freely surrender collateral in a Chapter 7 case if you want to, without worrying about owing the creditor or owing taxes for doing so.