The 3 Kinds of Debts

 Posted on April 06, 2016 in Bankruptcy Procedure

Your debts can be “secured,” “priority” or “general unsecured.” How bankruptcy treats your debts depends on which kind they are.

The purpose of bankruptcy is to deal with your debts. You want to know:

• Will you still owe anything to anybody after filing bankruptcy?
• What happens to debts you want to keep like a vehicle loan or home mortgage?
• How about special debts like income taxes and child support?

To answer these you have to know the 3 kinds of debts:

• secured
• priority
• general unsecured

Secured Debts

All of your debts are either secured by something you own or are not.

Usually it’s quite straightforward. If you have a vehicle loan, the vehicle’s title shows your lender as the lienholder. That lien on the title, plus what you agreed to in the documents you signed with that lender, makes the loan secured by the vehicle. So the lender has certain rights as a secured creditor related to your vehicle. It has the right to repossess your vehicle if you fail to make payments. It can likely “force-place” insurance and make you pay for it if you let your insurance lapse.

But sometimes you may not know whether a debt is secured or not. For example, you may have a credit card with a national retail chain but not know whether its balance is or is not secured by what you bought on that card. You’d have to look closely at the fine print on your card contract to know one way or other.

Sometimes a debt is intended to be secured but the creditor does not do what the law requires, and so the debt ends up being completely unsecured. The creditor would lose its rights to repossess whatever of yours it could have otherwise.

A debt could be fully secured or only partially secured. If you owe $12,000 on a vehicle worth only $9,000, the debt is only partially secured. It’s secured as to the $9,000 value of the vehicle and unsecured as to the remaining $3,000 of the debt.

A debt could be voluntarily or involuntarily secured. Involuntarily secured debts include a judgment lien on your home, an income tax lien on everything you own, and a mechanic’s or repairman’s lien for an unpaid bill on a repaired vehicle.

Priority Debts

Just like the word sounds, priority debts are particular ones that the law has selected to be treated better than other debts. For each type of priority debt there are reasons why it is treated special.

The different types of priority debts are themselves prioritized, as the following list shows. The most common priority debts for consumers or small business owners are the following, from the highest priority on down:

• child and spousal support—the amount owed as of the time of the filing of your bankruptcy case
• the administrative costs of the bankruptcy case—trustee fees and costs, and sometimes attorney fees
• wages and other compensation owed to employees, including employee benefits—maximum of $12,850 per employee, for work done in the final 180 days before the bankruptcy filing or close of business, whichever was first
• certain income taxes, and some other kinds of taxes—they are priority only if they meet certain conditions

In bankruptcy a lot turns on which debts get paid ahead of other debts. That often determines which debts get paid anything, and if so how much. This comes up differently under Chapter 7 “straight bankruptcy” and under Chapter 13 “adjustment of debts.”

In most Chapter 7 cases the trustee does not get any of your assets to distribe to your creditors. But in those cases where there are unprotected assets for the trustee to liquidate, the priority creditors are paid in full before the general unsecured ones receive anything. And the higher priority creditors are paid in full before the lower priority ones receive anything.

In Chapter 13 cases, the payment plan proposed by you as the debtor and approved by the court must show that you will pay all priority debts before the completion of your case. And then you have to in fact do so before you can finish the case and get a discharge (legal write-off) of your unpaid debts.

General Unsecured Debts

All debts that are not legally secured are considered unsecured debts. And “general” unsecured debts simply refer to those unsecured debts which are not priority debts. So general unsecured debts are the default category—if a debt is not secured and is not a priority debt, it’s a general unsecured one.

These include every imaginable type of debt or claim. The most common ones are most credit cards, virtually all medical bills, personal loans without any collateral, bounced checks, most payday loans (although those sometimes are secured), unpaid rent and utilities, older income taxes, balances left over after a vehicle is repossessed, most student loans, and uninsured or underinsured vehicle accident claims against you.

Sometimes debts which were previously secured become general unsecured ones, and vice versa. For example, once you’ve surrendered the vehicle on a vehicle loan, any remaining debt owed is a general unsecured debt. Or in the opposite direction, a general unsecured medical bill can become secured after a lawsuit is filed against you and a judgment entered, resulting in a judgment lien attached to your home.

In the next blog post we’ll get more into how debts in each category are treated under Chapter 7 and Chapter 13.