Chapter 7 vs. Chapter 13 and Your Personal Property Collateral

Law Office of Robert L. Firth Feb. 27, 2017

How does consumer bankruptcy protect the furniture, computer and such that you bought on credit?

Most people’s big worry about their collateral-secured debt is about their vehicle loan and/or home mortgage. So, appropriately most decisions about whether to file a Chapter 7 “straight bankruptcy” vs. a Chapter 13 “adjustment of debts” turns on which is better for their home and/or vehicle. That decision isn’t often driven by how other collateral is affected. But in your own situation, this may still be a major concern. How does bankruptcy help you with debts secured by other collateral?

Secured Debt on Personal Property

There are many kinds of debts secured by personal property (that’s everything other than real estate). There’s everything from business loans secured by inventory to income taxes with a tax lien on everything you own. Many of those unusual kinds of secured debts operate by special rules, and so have to be addressed separately.

But today we’re focusing on straightforward secured debt on tangible personal property such as furniture, appliances, and electronics.

There are two main categories. The first involves debt incurred to buy the collateral. Examples are store credit cards, a line of credit with the store, or a contract for a specific purchase. The second occurs when you already own something and provide it as collateral on a debt. An example is a loan for money from a money lender. Today we look at the first kind—“purchase money” secured debt.

Is the Collateral Really Collateral?

The first question is whether whatever you’re buying is really collateral on the debt related to the purchase. Does the creditor have a legal right to repossess the furniture or computer or whatever you bought?

The answer to that mostly depends on the terms of the contract in the transaction. Just because you owe money for buying something doesn’t necessarily give the creditor the right to repossess it. If you did not give the creditor that right within the contract, the debt is likely just an unsecured debt. (You often don’t know one way or the other.) If the debt is legally unsecured you could discharge (write it off) in bankruptcy without the creditor being able to make any claim on what you bought.

There’s often much more to this secured/not-secured question. For example, the revolving contract may make the purchased items collateral, but you’ve already paid off something you bought earlier. So some of what you bought would no longer collateral on the debt. There may be other complications like this in your situation. So this is something you clearly need to discuss with your attorney.

Will the Rights to the Collateral Be Enforced?

The next question is whether the creditor will bother to assert its rights to that collateral. Sometimes it’s just not worthwhile for them to enforce their contractual rights. Sometimes collateral depreciates so fast that it costs more to take it back than what they’d get out of it.

The contract only tells you what the creditor’s rights are, not whether it is enforcing them. That’s something only an experienced bankruptcy attorney would likely know.

Purchase Money Secured Debt in Chapter 7

Assume that the collateral IS legally tied to the debt, and the creditor IS enforcing its rights. Then your options in a Chapter 7 case are:

  • If you want to keep the collateral, enter into a “reaffirmation agreement” with the creditor. That’s a commitment to continue to be liable on either a portion of or the entire debt in spite of your bankruptcy, in return for your right to keep the collateral.

  • You may be able to keep the collateral without “reaffirming” your legal liability. You continue making payments until either pay off the collateral or surrendering it. The advantage: if you ever do surrender it, you would owe no “deficiency balance.” That’s a debt remaining beyond the value of the collateral. The disadvantage is that sometimes the collateral gets repossessed because you didn’t reaffirm the debt.

  • If you want to keep the collateral, “redeem” the collateral by paying its fair market value in a lump sum. You may be able to get a redemption loan owing much less than the debt you had on the collateral.

  • Surrender the collateral to the creditor if you don’t want it, and discharge the debt.

Purchase Money Secured Debt in Chapter 13

  • Assume you want to keep the collateral, and you bought it at least a year ago. In your Chapter 13 plan pay the lesser of the collateral’s fair market value or the loan’s balance within your 3-to-5-year case. If you bought the collateral less than a year ago, you’ll have to pay the full loan balance. Either way, when you finish your case you’d owe nothing to the creditor and would own the collateral outright.

  • If you want to surrender the collateral, you may end up paying something to the creditor. But that’s only if it claims you owe a deficiency balance. Also, that unsecured debt would just go into the pool of your other general unsecured debts. Often that just reduces what the other creditors would receive, without increasing how much you would have to pay.