This blog was written by Christopher Migliaccio, co-founder of Warren & Migliaccio, L.L.P. Chris is a recognized expert in bankruptcy law and has represented thousands of clients through the bankruptcy process. In this article Chris will reveal what debts are not forgiven when you file for bankruptcy.
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Which debts are forgiven in bankruptcy?
Filing for personal bankruptcy is often a last resort for individuals overwhelmed by debt. It can be an emotionally challenging decision, but for many, it offers a path to financial relief. However, it’s important to understand that not all debts are forgiven—or discharged—when you file for bankruptcy. The rules regarding which debts are forgiven depend on the type of bankruptcy you file and the type of debt.
Read on to learn more about which types of debts are forgiven after declaring personal bankruptcy.
Understanding the Different Types of Bankruptcy
In the United States, the two most common forms of personal bankruptcy are Chapter 7 and Chapter 13.
- Chapter 7 Bankruptcy, often referred to as “liquidation bankruptcy”, involves selling off a debtor’s non-exempt assets to pay off creditors. The remaining eligible debts are typically discharged, meaning they no longer have to be paid.
- Chapter 13 Bankruptcy, on the other hand, is known as a “reorganization bankruptcy.” It allows the debtor to keep their assets, with one restriction. It requires follow a court-approved repayment plan to be followed, lasting up to five years. At the end of the repayment period, some of the remaining debts may be discharged.
What is the difference between secured and unsecured debts?
When considering bankruptcy, it is critically important to understand the terms secured and unsecured debts. The difference between secured and unsecured debts lies primarily in whether the debt is backed by collateral.
Secured Debts
Secured debts are loans that are backed by collateral—an asset that the lender can take if the borrower fails to repay the loan. The collateral provides security for the lender, reducing their risk.
Some examples would include mortgages, car loans, and loans for luxury items like boats or jewelry. To remember secured debts, just think of the following:
- Collateral: If you default on a secured debt, the lender has the right to seize the collateral. For exampe, your home in the case of a mortgage, or your car in the case of an auto loan.
- Interest Rates: Secured debts often have lower interest rates because they are less risky for lenders.
Unsecured Debts
Unsecured debts are not backed by any collateral. The lender extends credit based on your creditworthiness, which is determined by factors like your credit score, income, and debt-to-income ratio.
Some examples could include credit card debt, medical bills, personal loans, and utility bills. To remember unsecured debts, recall the following points:
- No Collateral: Because there’s no collateral, unsecured creditors have fewer options if you default on the loan. They may pursue legal action to collect the debt. Such action could include filing a lawsuit or reporting the default to credit bureaus. However, they cannot directly seize your property.
- Interest Rates: Unsecured debts generally have higher interest rates compared to secured debts because they carry more risk for the lender.
Collateral is the Key
The main distinction between secured and unsecured debts is the presence or absence of collateral. Secured debts are tied to specific assets that can be repossessed by the lender if you default. Meanwhile, unsecured debts rely solely on your promise to repay and your financial reputation. Understanding this difference is crucial when managing your finances or considering bankruptcy, as it affects both your liability and the actions creditors can take in case of non-payment.
Debts That Are Typically Forgiven in Bankruptcy
Bankruptcy can provide relief from a variety of unsecured debts. Remember, unsecured debts are those not tied to any specific piece of property or collateral. Common examples of unsecured debts that may be discharged in bankruptcy include:
- Credit Card Debt: This is one of the most common types of debt discharged in both Chapter 7 and Chapter 13 bankruptcies.
- Medical Bills: These are usually forgiven in bankruptcy, offering relief to individuals overwhelmed by healthcare costs.
- Personal Loans: Unsecured personal loans, including payday loans, can often be discharged.
- Utility Bills: Past-due utility bills may be forgiven in bankruptcy.
What Debts Are Not Forgiven in Bankruptcy?
While bankruptcy can alleviate much of the financial burden associated with unsecured debts, many secured debts are not forgivable under any form of bankruptcy. Here’s a detailed look at some of those:
1. Student Loans
One of the most significant types of debt that is rarely forgiven in bankruptcy is student loans. Under current federal law, student loans are only dischargeable if the debtor can prove “undue hardship.” This is an exceptionally high standard to meet and requires demonstrating that repaying the loan would prevent the debtor from maintaining a minimal standard of living, that this hardship will persist for a significant portion of the repayment period, and that the debtor has made good faith efforts to repay the loan. Consequently, most people do not meet this standard, and student loans remain a financial obligation after bankruptcy.
2. Mortgages
Mortgages are tied to your home and are considered secured debts. In a Chapter 7 bankruptcy, you may be able to discharge the mortgage debt, but the lender retains the right to foreclose on the property to recover the loan. In Chapter 13 bankruptcy, you may be able to include past-due mortgage payments in your repayment plan, but you must continue to make regular mortgage payments to keep your home.
3. Car Loans
Like mortgages, car loans are also secured debts. If you file for Chapter 7, the lender may repossess the vehicle if you fail to continue making payments, although the remaining balance after the vehicle is sold could be discharged. In a Chapter 13 bankruptcy, you can include past-due car payments in your repayment plan, but you must continue making your regular payments to keep the vehicle.
4. Loans for Luxury Vehicles, Boats, or Other High-Value Items
Loans for luxury items, such as high-end vehicles or boats, are secured by the purchased item itself. Similar to car loans and mortgages, these debts may not be forgiven in bankruptcy unless the asset is surrendered to the lender. If you wish to keep the luxury item, you’ll need to continue making payments.
5. Child Support and Alimony
Debts related to child support and alimony are considered priority debts and are not dischargeable under either Chapter 7 or Chapter 13 bankruptcy. These obligations must continue to be paid in full, regardless of your bankruptcy status.
6. Tax Debts
Most tax debts are not dischargeable in bankruptcy. However, under certain conditions, some older tax debts may be discharged if they meet specific criteria, such as being income tax debt, with a tax return that was filed at least two years before the bankruptcy filing. Nonetheless, recent tax debts, payroll taxes, and fraud penalties are not dischargeable.
7. Business Loans
If the business loan is unsecured, it may be discharged under Chapter 7 or Chapter 13 bankruptcy, similar to credit card debt. However, if you have personally guaranteed the loan or if it’s secured by business assets, the rules become more complex and some debts are not forgiven. The specifics will depend on the terms of the loan agreement and whether the bankruptcy is personal or business-related.
8. Debts Arising from Fraud or Willful Misconduct
Debts incurred through fraudulent activity, embezzlement, or willful and malicious conduct are not dischargeable in bankruptcy. Creditors can challenge the discharge of such debts, and if proven, these debts will survive the bankruptcy.
9. Loans with Family Members and Other Informal Loans
Loans from family members or friends, while technically unsecured, can create complications in bankruptcy. If there is a written agreement, the loan may be treated similarly to other unsecured debts. However, any preferential payments made to family members before filing for bankruptcy could be scrutinized by the court. Such payments could be clawed back to ensure equitable treatment of all creditors.
What About Payday Loans?
Payday loans are generally considered unsecured debts, and in most cases, they can be discharged in bankruptcy. However, if the court determines that the payday loan was taken out fraudulently (e.g., if you had no intention of repaying it), it may not be forgiven.
What can you do if you have lots of secured debts that are not forgiven with bankruptcy?
If you have a significant amount of secured debts that cannot be forgiven through bankruptcy, there are several strategies you can consider to manage your financial situation. Here’s a detailed look at your options:
1. Negotiate with Creditors
One of the first steps you can take is to negotiate directly with your creditors. Creditors may be willing to work with you to modify the terms of your loan, especially if they believe it increases their chances of being repaid.
- Loan Modification: This might involve extending the repayment period, reducing the interest rate, or even deferring payments temporarily.
- Settlement: In some cases, creditors may agree to settle the debt for a lump sum payment that is less than the total amount owed.
2. Refinance Your Loans
Refinancing involves taking out a new loan with better terms to pay off your existing secured debts. This can be a good option if you can secure a lower interest rate or a longer repayment period, which can reduce your monthly payments.
- Mortgage Refinancing: If you have equity in your home, refinancing your mortgage could lower your monthly payments or allow you to consolidate other debts.
- Auto Loan Refinancing: If your car loan has a high-interest rate, refinancing might lower your payment.
3. Sell the Secured Asset
If you’re unable to keep up with payments and don’t see your financial situation improving, selling the secured asset may be a viable option.
- Selling a Home: If you’re underwater on your mortgage, selling the home might allow you to pay off the debt and avoid foreclosure.
- Selling a Vehicle: If you can’t afford your car payments, selling the vehicle and using the proceeds to pay off the loan can help you avoid repossession.
4. Prioritize Secured Debts
If you have both secured and unsecured debts, focus on paying off the secured debts first. This strategy helps you avoid the loss of essential assets like your home or car.
- Budgeting: Create a detailed budget that prioritizes payments for secured debts over discretionary spending and lower-priority debts.
- Debt Snowball or Avalanche Method: While typically used for unsecured debts, you can adapt these methods to prioritize paying off secured debts.
5. Chapter 13 Bankruptcy
While Chapter 7 bankruptcy may not discharge secured debts without surrendering the collateral, Chapter 13 bankruptcy could provide a way to keep your assets.
- Repayment Plan: Chapter 13 allows you to restructure your debt and create a court-approved repayment plan. You can catch up on missed payments over three to five years while keeping the secured asset.
- Cramdown: In some cases, Chapter 13 allows for a “cramdown,” where the loan balance is reduced to the current market value of the secured asset, such as a car. This is typically not available for primary residences.
6. Voluntary Surrender
If keeping the secured asset is no longer financially viable, you can voluntarily surrender it to the creditor. This is often a better option than having the asset repossessed or foreclosed, as it can minimize additional fees and damage to your credit.
- Negotiating Surrender Terms: Work with the lender to surrender the asset on mutually agreeable terms, which might involve avoiding a deficiency judgment (the remaining balance after the asset is sold).
7. Credit Counseling
Seeking help from a certified credit counselor can provide you with guidance on how to manage your secured debts. They can help you create a debt management plan (DMP) that consolidates your debts into one monthly payment and negotiates with creditors on your behalf.
- Debt Management Plan: While this typically focuses on unsecured debts, a credit counselor can also provide advice on managing secured debts and may help negotiate with your creditors.
8. Explore Government Assistance Programs
Depending on your situation, there may be government programs available to help you manage or refinance secured debts, particularly for mortgages.
- Home Affordable Refinance Program (HARP): Although it expired in 2018, similar programs may exist that can help underwater homeowners refinance their mortgages.
- Loan Forbearance Programs: If you’re facing temporary financial hardship, some lenders offer forbearance programs that allow you to pause or reduce payments temporarily.
9. Consider Downsizing
If your secured debts are tied to assets that are more expensive than necessary, consider downsizing. Moving to a smaller home, trading in a luxury vehicle for a more affordable one, or selling off high-value assets can reduce your debt burden.
10. Seek Legal Advice
If your situation is complex or if you’re facing legal action from creditors, consulting with a bankruptcy attorney or debt relief attorney is crucial. They can provide personalized advice and help you explore all available options, including the potential for legal action against lenders if there were any violations of lending laws.
Get Advice Before Taking Action
Dealing with secured debts that cannot be forgiven through bankruptcy requires a strategic approach. By exploring options like negotiation, refinancing, selling assets, or even Chapter 13 bankruptcy, you can manage your debts more effectively. Remember, it’s essential to act sooner rather than later to avoid losing valuable assets or damaging your credit further. If you need help navigating your options, don’t hesitate to reach out for a free consultation with a knowledgeable attorney who can guide you through the process.
Considering Bankruptcy? Get Professional Help
Bankruptcy laws are complex, and the rules about which debts are not forgiven can vary significantly depending on the specifics of your situation. Before deciding to file for bankruptcy, it’s crucial to consult with an experienced bankruptcy attorney who can guide you through the process and help you understand your options.
At Warren & Migliaccio, L.L.P., we have extensive experience helping individuals navigate the complexities of bankruptcy. Our team is here to provide the advice and representation you need to make informed decisions about your financial future. We offer free consultations to discuss your unique situation and determine the best course of action.
If you’re considering bankruptcy or simply want to learn more about your options, call us at (888) 584-9614 for a free consultation. We’re here to help you take control of your financial life.
