Secured Debt & Bankruptcy
WHAT IS SECURED DEBT?
Secured debt is debt that is tied to or secured by an asset, such as a mortgage. The most common type of secured debt is a purchase-money loan that is tied to the asset purchased. When you buy a home or other real estate and finance that purchase with a bank loan, you will sign two documents at the closing: (1) a mortgage note which states how much money you owe the bank for purchasing the real estate and what the terms of payment are; and (2) a mortgage lien, which gives the bank the right to take the property back if you don’t comply with the terms of the mortgage note. When you purchase and finance a vehicle through a loan, there are two separate obligations you agree to in the process of purchasing the vehicle: (1) you sign a promissory note which states how much you owe the bank for purchasing the vehicle and what the terms of repayment are; and (2) a security agreement that gives the bank a security interest in the vehicle and the right to repossess the vehicle if you don’t comply with the terms of the promissory note. If you don’t pay the note as required by its terms, then you have defaulted and the bank can then foreclose on the mortgage or repossess the vehicle.
These types of purchase-money security interests are called “voluntary liens” because when you took out the loan to purchase the asset, you voluntarily gave them a lien on the asset.
Another type of secured debt is an “involuntary lien” which is a lien placed against your property without your permission. This can happen as a result of a judgment in a lawsuit or a tax lien being filed on your property.
WHAT HAPPENS TO MY SECURED DEBT IN CHAPTER 7 BANKRUPTCY?
Dealing with secured debt and liens in bankruptcy can be complicated. When you file bankruptcy, you are required to list all debts in your petition, including your mortgage and vehicle loans. This does NOT mean that you will lose those assets. It is simply a requirement of bankruptcy law. You will have the option to keep your house and your vehicle if you continue to make payments on those loans. So long as you keep paying your mortgage payment after bankruptcy, you can keep your house (this is true whether or not you sign a “reaffirmation agreement” for the mortgage). Some secured lenders, usually credit unions, will request that you sign a “reaffirmation agreement” during your bankruptcy if you want to keep your vehicle.
WHAT IS A REAFFIRMATION AGREEMENT?
A reaffirmation agreement is a formal bankruptcy form that you sign agreeing to be bound by the original terms of a secured loan after bankruptcy. The lender can’t change the terms of the loan for the worse in a reaffirmation agreement, but sometimes lenders will offer better terms to entice you to sign the reaffirmation agreement. The benefits to signing a reaffirmation agreement is that the lender can (but doesn’t have to) report your payments to your credit report after bankruptcy, helping to build your credit score. The downside to signing a reaffirmation agreement is that the reaffirmation agreement re-obligates you to the terms of the loan and you remain personally liable for the loan; if you ever default on the terms of the loan, the lender could sue you. At Prescott Pearson & Tande, PA we have the experience to make sure that your property is properly protected and your secured debt is properly dealt with.
CAN I REMOVE LIENS FROM MY PROPERTY IN CHAPTER 7 BANKRUPTCY?
Chapter 7 bankruptcy cannot remove voluntary liens from property. The choice in a Chapter 7 bankruptcy with secured debt is all-or-nothing: if you want to keep the house or car that is secured by the lien, then you must keep making the payments on the loan; if you want to get rid of the secured debt, the lender has the right to take back the property.
Chapter 7 bankruptcy can in certain cases remove involuntary liens from property to the extent that the lien affects your right to exempt that property. The most common example of this is a judgment lien. Judgment liens on homestead real property can be removed or “avoided” if certain conditions are met. Avoiding a judgment lien on a homestead is a complicated process. Fortunately, Minnesota law has a much easier process for nullifying a civil court judgment that is impacting homestead real property, and this is something we do regularly for our clients.
WHAT CAN CHAPTER 13 DO WITH SECURED DEBT?
While Chapter 7 leaves very few options for dealing with secured debt, Chapter 13 provides for much more flexibility in dealing with secured debt. In short, in a Chapter 13, we can modify, reduce, or even eliminate some secured creditors’ lien rights. Here are a couple of specific ways that we can change lien rights to your benefit:
CURING MORTGAGE AND CAR LOAN ARREARS
When a person falls behind in payments to a secured creditor, that secured creditor can try to get the collateral back through foreclosure or repossession. Filing a Chapter 13 can stop a sheriff sale on real estate and prevent the repossession of a vehicle. The Chapter 13 can provide that you will keep the collateral during the bankruptcy and catch up the missed house or car payments over an extended period of time through payments from the Chapter 13 plan.
LIEN STRIPPING OF SECOND MORTGAGES
A Chapter 13 plan can eliminate a second mortgage where the value of the real estate securing that second mortgage is less than the amount owed on the first mortgage. This is a complicated process, but we have successfully stripped off second (and even third) mortgages for dozens of our Chapter 13 clients.
REDUCING THE INTEREST RATE ON VEHICLE LOANS
It is common to see interest rates on vehicle loans in excess of 20%. One of the features of a Chapter 13 bankruptcy is that we can provide for the payment of your vehicle through monthly payments at a much lower interest rate. The interest rate used is the prime interest rate on the date the case was filed, plus 1%.
REDUCING THE AMOUNT OWED ON VEHICLE LOANS
If the vehicle was financed over 910 days prior to the filing of the bankruptcy (about 2.5 years), the Chapter 13 plan can provide to pay only the value of the vehicle to the lender, not the total loan amount. Any amount owed over the vehicle’s value would be treated as an unsecured claim and discharged at the end of the Chapter 13 plan.
ELIMINATING “CROSS COLLATERAL” CLAIMS ON VEHICLES
Credit unions have a tricky and not-well-known option to tie all non-real estate loans to collateral securing only one loan. For instance, if you have a car loan, credit card, and personal loan all through the same credit union, the credit union can secure all of that debt with the vehicle – meaning that to pay off the vehicle, you have to pay off all of the debt. A Chapter 13 plan can eliminate the claims of the other cross-collateralized debts on the asset.