If you pledge an item of property as collateral for a loan, that obligation is called a secured debt. While a Chapter 7 bankruptcy discharge wipes out your personal liability for secured debts, it doesn’t eliminate the lender’s lien on the property. This means that your lender can still foreclose on or repossess the asset if you default on the obligation. Read on to learn more about your options for dealing with secured debts in Chapter 7 bankruptcy.
For more information on what happens to different types of debt in Chapter 7 bankruptcy, see our topic area on Your Debts in Chapter 7 Bankruptcy.
Secured Debts in Bankruptcy: Personal Liability v. Lender's Lien
When a debt is considered secured, it means that:
- you have a personal obligation to pay back the debt, and
- your lender has a lien on the property you pledged as collateral.
If you stop making payments on a secured obligation, the lender’s lien allows it to foreclose on or repossess the property to satisfy its loan. If the value of the asset is not enough to cover your outstanding loan balance, the lender can also sue you to collect the remaining loan amount (called a deficiency balance).
Filing for Chapter 7 bankruptcy eliminates your personal liability for the secured debt. But it doesn’t get rid of the lender’s lien on the property. If you don’t make your payments, your lender can still foreclose on or repossess the asset after your bankruptcy (but it can’t sue you to collect a deficiency).
How to Deal With Secured Debts in Chapter 7 Bankruptcy
In Chapter 7 bankruptcy, you have several options for dealing with secured debts including:
- surrendering (giving back) the asset
- reaffirming the debt, and
- redeeming the property.
Surrendering the Property
If you no longer want to keep the property and make payments on the debt, Chapter 7 bankruptcy allows you to simply give the asset back to the lender and walk away from the obligation. Because your discharge wipes out your personal liability for the debt, your lender’s recovery is limited to the value of the property.
If the lender can’t sell the asset for enough money to satisfy the entire loan balance, it can’t come after you to collect the rest because the deficiency is discharged in your bankruptcy. If you want to surrender your property, you must check the appropriate box on your Statement of Intention and send a copy of the form to your lender.
For more detailed information on how to surrender your property, see Surrendering Secured Property in Chapter 7 Bankruptcy.
Reaffirming the Debt
If you want to keep the property, one of your options is to sign an agreement with your lender to reaffirm the debt. A reaffirmation agreement is essentially a new contract you enter into that makes you personally liable for the debt again despite your bankruptcy discharge.
Because you are waiving the benefit of your discharge by reaffirming, make sure the agreement is in your best interest before signing it. Keep in mind that the lender wants you to reaffirm the debt -- this means you may be able to negotiate the terms of the new agreement. In most cases, it is not a good idea to reaffirm a debt if:
- you don’t need the property
- the amount of the reaffirmed debt exceeds the value of the property, or
- the interest rate is too high.
To learn more about how reaffirmation works, see Reaffirmation Agreements in Chapter 7 Bankruptcy.
Redeeming the Property
You may also be able to keep your property by redeeming it. To redeem an asset in Chapter 7 bankruptcy, you pay the lender the replacement value of the property in one lump sum. This is typically a great option if the value of the property is significantly lower than what you owe on the debt.
The downside of redemption is that you normally must come up with the money in one lump sum. Most Chapter 7 debtors don’t have enough cash to pay their lender the replacement value of their property. But keep in mind that there are companies who specialize in providing loans to debtors who want to redeem property in Chapter 7 bankruptcy. Those loans often come with high interest, however. Think carefully before you get yourself back into the credit treadmill.
For more information on how to redeem your property, see Redeeming Property in Chapter 7 Bankruptcy.