Can You File Bankruptcy on a Secured Loan?
Discover how secured loans are treated in bankruptcy. Learn your options for debts tied to assets, from mortgages to auto loans.
Bankruptcy provides a legal pathway for individuals facing overwhelming financial challenges to seek relief and a fresh start. This federal process addresses outstanding debts that have become unmanageable. It allows for the discharge of certain obligations, providing debtors an opportunity to rebuild their financial standing.
Understanding Secured Loans in Bankruptcy
A secured loan is a type of debt where the borrower pledges an asset as collateral. This collateral acts as security for the lender, minimizing their risk if the borrower fails to repay the loan. Common examples of secured loans include mortgages, where the home itself serves as collateral, and auto loans, where the vehicle secures the debt.
The lender’s legal claim on this collateral is known as a lien. If a borrower defaults, the lender can seize and sell the collateral to recover the outstanding balance. This distinguishes secured loans from unsecured loans, such as credit card debt, which are not tied to specific assets.
Secured Loans in Chapter 7 Bankruptcy
Chapter 7 bankruptcy, often called liquidation bankruptcy, offers specific options for debtors dealing with secured loans. Debtors must decide how to handle these debts, with three primary choices: surrender, reaffirmation, or redemption.
Surrendering the collateral involves returning the asset to the lender. This eliminates the debtor’s personal responsibility for the debt, which is then discharged. For example, a debtor might surrender a car they can no longer afford, and the associated loan debt is discharged. While the lender can repossess or foreclose, any remaining balance after the sale is typically discharged, preventing a deficiency judgment.
Reaffirmation is an agreement to continue paying a secured debt, thereby retaining the collateral. This choice is made for assets the debtor wishes to keep, such as a home or a car. The debtor signs a formal reaffirmation agreement, which re-establishes personal liability despite the bankruptcy filing. This agreement requires court approval. If the debtor defaults on a reaffirmed debt, they remain personally liable, exposing them to collection actions like lawsuits or wage garnishment.
Redemption allows a debtor to keep personal property by paying the lender its current fair market value in a single lump sum. This option is used when the loan amount significantly exceeds the asset’s actual worth. For instance, if a car loan is $11,500 but the car is worth $5,500, the debtor can pay $5,500 to own it free and clear. This discharges the remaining balance. Redemption is available for tangible personal property intended for personal, family, or household use.
Secured Loans in Chapter 13 Bankruptcy
Chapter 13 bankruptcy, a reorganization bankruptcy, involves a court-approved repayment plan spread over three to five years. Secured debts are treated differently in this context, often incorporated into the payment plan itself. This approach allows debtors to manage their obligations while retaining their assets.
Payments for secured debts can be made through the Chapter 13 plan, which provides a structured way to cure any defaults and reinstate the original loan terms. If a debtor is behind on mortgage payments, for example, the plan can include provisions to catch up on arrears while maintaining regular monthly payments. This structured repayment offers debtors a pathway to avoid foreclosure or repossession.
A notable feature in Chapter 13 for certain secured loans is the “cramdown.” This mechanism allows a debtor to reduce the principal balance of a secured loan to the actual fair market value of the collateral. The remaining portion of the debt, exceeding the collateral’s value, is then reclassified as unsecured debt. For example, if a car has a fair market value of $5,000 but the loan balance is $10,000, a cramdown could reduce the secured portion of the loan to $5,000, with the remaining $5,000 treated as unsecured.
The cramdown provision applies to vehicle loans and mortgages on investment properties, but not usually to mortgages on a debtor’s primary residence. A significant condition for vehicle cramdowns is the “910-day rule,” which requires the car to have been purchased at least 910 days (approximately 2.5 years) before the bankruptcy filing. This rule prevents cramdowns on recently acquired vehicles.
Similar to Chapter 7, surrendering collateral is an option in Chapter 13. If a debtor no longer wishes to keep an asset, they can surrender it, and the associated debt will be discharged. The lender can then proceed with repossession or foreclosure, with any deficiency balance typically treated as an unsecured claim within the bankruptcy plan.