Stop secured creditors from taking your property, unsecured debts from turning into secured ones. Keep or surrender collateral as you wish.
Our last blog post a couple days was about secured debts. We explained that for a debt to be legally secured against something you own the creditor must go through certain steps to accomplish that, or else it won’t be secured. We showed how you could contractually enter into a secured debt voluntarily. But our blog post also showed that a creditor can turn its unsecured debt into a secured one by suing you or using other means of involuntarily imposing a lien on your possessions and/or real estate.
Today we look at how bankruptcy—specifically Chapter 7—can give you certain powers and advantages over your secured debts.
The Chapter 7 Powers Over Secured Debts
When you file a Chapter 7 “straight bankruptcy” case, doing so:
1) stops your creditor from taking your property which secures a secured debt;
2) prevents a creditor with an unsecured debt from turning it into a secured one;
3) enables you keep property which already secures your debts; and
4 allows you, if you want to give up any property which secures a debt, to give up that property to the creditor without owing anything more on the debt.
–Stop Creditors from Taking Your Property
As of the moment your Chapter 7 case is filed, your secured creditors are immediately stopped from taking possession of whatever you own that secures their debts. This protection comes from the “automatic stay,” the federal law that stops virtually all collection activity by all your creditors again you, your income, and your assets.
The U.S. Bankruptcy Code specifically states in its section on the “automatic stay” that the filing of a bankruptcy petition “operates as a stay, applicable to all entities, of… (3) any act to obtain possession of property … or to exercise control over property… [and] (5) any act to… enforce against property of the debtor any lien… .” See Section 362(a)(3) and (5) of the Bankruptcy Code. That is, a creditor with a secured debt may not obtain possession or exercise control over your property securing its debt, or enforce its lien on such property, while the “automatic stay” is in effect.
Your vehicle lender can’t repossess your vehicle, or enforce its lien against your vehicle, for example.
This “stay” is in effect either temporarily or permanently. It’s in effect during the time that a Chapter 7 case is active. But normally that’s only a period of about 4 months. You have that amount of time, and sometimes shorter, to make a deal with your secured creditors about either keeping or surrendering property in which they have a lien.
–Prevent Creditors from Turning Unsecured Debts into Secured Ones
The “automatic stay” not only stops secured creditors from enforcing its liens against your property. It also stops creditors with unsecured debts from acquiring new liens against your property. The “automatic stay” prevents unsecured debts from being turned into secured ones.
There are various ways that creditors can do that if you have not filed bankruptcy. Virtually all creditors could sue you, get a judgment against you and a judgment lien against all or much of your property. Or the IRS and state tax agency could get a tax lien against all or most of your property for unpaid taxes. If you get behind on child or spousal support, your ex-spouse or support enforcement agency could impose a support lien against your property. There are many other similar kinds of liens that can be created on your property.
Since creditors with secured debts have much more leverage in bankruptcy than those with unsecured creditors, preventing creditors from acquiring a lien in what you own is an important benefit.
–Enable You to Keep Property Securing a Debt
If you want to keep your property in which a creditor has a lien, Chapter 7 bankruptcy can help a number of ways:
- If you are current in your payments on a secured debt and want to keep the collateral, you are virtually always allowed to do so. Your creditor is usually very happy to let you keep making payments to keep the account in good standing.
- If you have fallen behind on your payments on a secured debt, you will usually be given a certain amount of time to bring the account current. Catching up on payments—such as on a vehicle loan—should be easier for you to do when you no longer have to pay other creditors after filing a Chapter 7 case.
- In limited situations the payment terms of the debt may be renegotiated (such as with a home mortgage modification). As a result you may be able to avoid having to catch up on late payments, negotiate a lower interest rate, and perhaps even lower the monthly payment and/or principal balance.
- Very specific kinds of secured debts, and only under certain circumstances, can be turned into unsecured debts. For example, judgment liens on your home may be “avoided”—taken off your home’s title—and the debt is “discharged” so you pay nothing.
–Allow You to Surrender Property Securing a Debt
If, without filing bankruptcy, you simply surrender collateral to a creditor because you can’t afford the payments, or simply do not need or want the collateral any more, you can end up still owing much of the debt. That’s because after the creditor sells the surrendered collateral for less than the balance, and adds in its repossession and other costs, you could easily end up still owing much of the balance. And the creditor will have the right to sue you for that balance.
In addition, if the creditor were to write off all or part of that remaining balance (through a negotiated settlement, for example), you could be hit with a significant income tax obligation. The amount forgiven may be considered “cancelation of debt income,” which is then treated as income upon which you have to pay income taxes. See the IRS’s “Tax Topic” on “Canceled Debt” and its information specifically on “Home Foreclosure and Debt Cancelation.”
Chapter 7 solves both of these problems. It would almost always “discharge” (permanently write off) any balance owing after the surrender of any collateral. And the “discharge” of debts in bankruptcy is treated as an IRS exclusion of “cancelation of debt income.” So any forgiveness of debt is not considered income and it’s not taxed.
As a result you can freely surrender collateral in a Chapter 7 case if that is what you decide is best for you.