A Chapter 7 bankruptcy is a great option if you are looking to get out from under the weight of significant debt. Through this process, many of your debts will be effectively discharged and you will have a “fresh start”.
However, it’s important to note that different rules apply to debts that are “secured”. Here, while the underlying debt may be canceled, the creditor is often entitled to take back the property that was involved in the transaction (referred to as collateral).
If you are in this situation, you do have a few options. You may relinquish the property to the creditor, redeem the property, reaffirm the underlying debt, or retain the collateral and pay the money you owe.
What is a Secured Debt?
As mentioned, there are certain types of debts that are backed by collateral. This property guarantees payment of the debt, so the transaction is considered “secured”. If you are unable to pay what you owe on a secured debt, the creditor can repossess the item.
Common examples of secured debts would be a mortgage on your house or a car loan. Keep in mind that a secured transaction can be created without your consent. An example would be a lien placed on your property as a result of a court judgment or based on delinquent taxes.
By contrast, an unsecured debt does not involve any collateral. This means that there is no property that a creditor can repossess if you fail to make payments. Examples include most credit card debt and back rent.
When to Surrender the Property
That said, your first option, if you can’t stay current on payments for a secured debt, is to simply surrender the collateral. Here, you allow the creditor to take the property back. In this case, you would lose possession of the item but you would no longer be responsible for the underlying debt.
This is typically the best option if you don’t need the property. Further, it is up to the creditor to make arrangements to collect the item. This means that if neither the creditor nor the bankruptcy trustee chooses to claim the collateral, you will be able to keep possession of the property.
Now, you may be curious why this would happen. Often it occurs in cases where the property has little or no value. An example might be artwork that has drastically declined in value since the date the loan was created. However, you should never assume that a creditor won’t choose to repossess the item (even if it has low value).
When to Redeem the Property
Another option is what is referred to as redeeming the property. Here, you would pay the creditor the item’s current replacement value, typically in the form of a lump sum. Keep in mind that the replacement value may be different than the amount of money you owe on the debt.
Once the process is complete, the property then becomes fully yours and the underlying debt is wiped out. However, only property part of a secured transaction that meets the following requirements can be redeemed:
- The transaction must be for consumer debt (i.e. not a business debt)
- The item must involve tangible personal property (i.e. not real estate or stocks),
- The property must be claimed as exempt OR abandoned by the bankruptcy trustee
Now, redemption is a good option for a debtor in cases where the debt is larger than the value of the property. But, note that a significant drawback to this course of action is that you must have the necessary cash available to redeem the item.
When to Reaffirm the Debt
As an alternative, you might consider reaffirming the debt. Here, you would keep both the property and the debt. In this case, it would be like you never filed for bankruptcy. Bear in mind that if you reaffirm and later fall behind on payments, the creditor has the option of going to court and seeking a deficiency judgment for the outstanding balance.
This is important because the judgment may preclude you from filing for bankruptcy for a period. However, this is still a good option for debtors that want to keep their property and have the ability to make payments. But, note that this goes against the highly beneficial “fresh start” purpose of bankruptcy. For that reason, always think carefully before selecting this option.
When to Retain and Pay
The final option you can pursue is what is known as “retain and pay”. This is also commonly referred to as the “ride-through” option. In this case, you would keep the property as long as you stay current on payments. It is distinguished from the reaffirm option because if you fall behind on payments the creditor seeks possession of the property rather than obtaining a deficiency judgment.
Note that the creditor has to agree to this option. Further, while this was a great choice for debtors in the past, changes to the bankruptcy code that occurred after 2005 have made it unclear as to whether it is still a viable course of action. As of the writing of this article, some courts/judges allow it and some don’t. For that reason, it’s important to speak with a Riverside bankruptcy attorney that can help you decide whether this option is right for you.