Your car loan, home mortgage, account at the appliance or electronics store, and maybe a debt that’s resulted in a judgment lien—these debts with collateral are the ones that grab the most attention during a bankruptcy case. And that includes the attention of the creditors, very interested in “their” collateral.
General unsecured debts are pleasantly boring in most bankruptcy cases. In a Chapter 7 case, they are generally discharged (legally written off) without any opposition by the creditors, who usually get nothing. And in a Chapter 13 case, general unsecured debts are often just paid whatever money is left over after the secured and priority debts, and the trustee and attorney fees, are paid. Nice and boring. That’s because the creditors don’t have much to fight about.
But with secured debts—debts with collateral—both sides have something to fight about: the collateral. The creditors know that the vehicle or house or other collateral is the only thing backing up the debt you owe to them, so they can get quite pushy about protecting that collateral.
There are a few basic points to remember that apply to just about all secured debts:
Two Deals in One
It helps to look at any secured debt as two interrelated agreements between you and the creditor. First, the creditor agreed to give you money or credit in return for your promise to repay it on certain terms. Second, you received rights to—and usually title in—the collateral, with you in return agreeing that the creditor can take that collateral if you don’t comply with your first agreement to repay the money.
Generally, bankruptcy will absolve you of that first agreement—your promise to pay—but the creditors’ rights to collateral survive bankruptcy (except in certain rare situations we will highlight later). Your ability to discharge the debt gives you some options, and can sometimes give you a certain amount of leverage. But the creditors’ rights to the collateral give them certain options and leverage, too. You’ll see how this tug-of-war plays out with vehicle and home loans, and few other important secured debts.
Value of Collateral
In that tug-of-war between your power to discharge the debt and a creditor’s rights to the collateral, how much the collateral is worth as compared to the amount of the debt becomes important. If the collateral is worth a lot more than the amount of the debt, the creditor is said to be well-secured. It has a better chance of having the debt paid in full. You’ll want to pay off the relatively small debt to get the relatively expensive collateral free and clear of that debt. Or, if you didn’t make the payments, the creditor will get the collateral and sell it for at least as much as the debt.
If the collateral is worth less than the amount of the debt, the creditor is said to be “undersecured”. It is less likely to have this debt paid in full. You might be less likely to pay a debt only to get collateral worth less than what you’re paying. And if you surrender the collateral the creditor will sell it for less than the debt amount.
Depreciation of Collateral, and Interest
With the value of the collateral being such an important consideration, the loss of value through depreciation is something that creditors care about, a concern which the bankruptcy court respects. Also, secured creditors are usually entitled to interest. So, you’ll see that in fights with secured creditors, this issue about the combined amount of monthly depreciation and interest often comes into play.
Insurance
Virtually every agreement with a secured creditor—certainly those involving vehicles and homes—requires that you carry insurance on the collateral. If the collateral is damaged or destroyed, this insurance usually pays the debt on the collateral before it pays you anything. And, if you fail to get the required insurance—or sometimes even if you simply don’t inform the creditor about having the insurance—the creditor itself is entitled to buy “force-placed” insurance to protect only its interest in the collateral, AND charge you the often outrageously high premium.
