What happens to liens on your property if you file for Chapter 7 bankruptcy? If a creditor has a lien, the creditor has rights against your property which secure your obligation to pay money you owe. Generally, if you don’t pay a lien creditor, it can take steps to take your property to satisfy the debt. In most cases, filing for bankruptcy under Chapter 7 stops the secured creditor from taking your property but the reprieve may be temporary.
The General Rule: Liens Survive Bankruptcy
The general rule is that a lien survives bankruptcy unchanged. This means that filing for bankruptcy, by itself, does not eliminate liens. To understand how this works, you need to learn:
- how liens are created, and
- the difference between a lien and your personal obligation to pay a debt.
How Liens Are Created
Liens can be created by agreement or by law. Debts that are secured by property (real estate or personal property) are called secured debts. The property that secures a debt is called collateral.
By Agreement. An example of a lien created by agreement, or a consensual lien, is a mortgage. When you take out a loan to buy a house, you generally agree to give the lender a lien called a mortgage, on your house. If you stop making your house payment, the mortgage gives the lender the right to foreclose and have your house sold to pay off your debt.
By Law. A tax lien is an example of a non-consensual lien, or lien that is created by law without your agreement. If you don’t pay your federal taxes, the law allows the IRS to lien your property. If you still don’t pay, the IRS can take steps to sell your property to satisfy your tax debt. Another example is a judgment lien. If a creditor obtains a judgment against you, the creditor can take steps to make the judgment a lien on your property. Then, if you don’t pay, your property can be seized and sold to pay the judgment.
To learn more about the different types of liens, see Types of Liens.
Requirements Differ by State
There are some situations where liens are created automatically, but in most cases the creditor must take steps to "perfect" its lien by complying with legal requirements to record or file the lien. State law often sets the requirements, including when and where a lien must be filed. You may have defenses to the enforcement of a lien if the creditor does not file it timely or properly.
Personal Obligation to Pay vs. Lien Rights
When you borrow money or incur debt, you create a personal obligation to pay. Your personal obligation to pay is separate from a creditor's lien rights. Not all creditors have lien rights. Credit card debt is an example of a situation where you have a personal obligation to pay a debt that is not secured by a lien. When there is a lien, such as a mortgage, the lien gives the creditor rights against your property which provide extra assurance that the money you owe can be recovered. In bankruptcy, the distinction between your personal obligation to pay and the creditors lien rights is very important.
The Effect of a Bankruptcy Discharge
When you receive a discharge in bankruptcy, your personal obligation to pay your discharged debts, including those secured by liens, is extinguished. A creditor who does not have lien rights cannot take any action to collect discharged debts. But if the creditor has a lien on your property, that creditor has the right to enforce the lien and satisfy the debt from the sale of the collateral even though your personal obligation was discharged.
The Automatic Stay
In most cases, the automatic stay prohibits lien creditors from enforcing their lien rights when you file for bankruptcy. But unless you can take action to eliminate the lien, this relief is temporary only. If you have claimed the collateral as exempt, the stay is lifted automatically and secured creditors are allowed to proceed to collect against the collateral when you receive your discharge. If the collateral is not claimed as exempt, the creditor may have to wait until the bankruptcy case is closed or until they get permission from the bankruptcy court to proceed. Most Chapter 7 cases are closed soon after the discharge is granted.
Avoiding Liens in Bankruptcy
There are steps you can take to avoid (eliminate or limit) certain liens in bankruptcy. The types of liens that can be avoided and the methods for avoiding them vary depending on
- the circumstances of your case
- choices you made when you filed for bankruptcy, and
- the law in your particular district.
Lien avoidance does not happen automatically and is more limited in Chapter 7 than Chapter 13, but using the right methods and under the right circumstances, it can eliminate or limit liens that
- impair your exemptions,
- are not properly perfected, or
- exceed the value of the collateral.
(For more information, see Dealing with Liens in Bankruptcy.)