The Differences Between Secured Debt and Unsecured Debt

By: Liz Roberts

When filing for bankruptcy, it is important to consider whether the debt you owe is a secured debt or an unsecured debt. The court's ruling will depend on what specific type of debt you owe to your creditors.

How does a secured debt differ from an unsecured debt? As the name suggests, a secured debt uses a form of security for the money owed. The security may be real estate property such as a home or a lot. The borrower signs a contract that agrees to surrender this property in case he fails to pay off his dues. Thus, the security or collateral serves as protection for the creditor against the risk of default. The most common examples of secured debts are car loans and mortgage loans.

On the other hand, with an unsecured debt, the borrower is not required to submit any form of security or collateral to his creditor. The creditor will grant a loan approval solely based on the borrower's credit history. An unsecured debt has a higher interest rate than secured debt because it puts a higher risk for the lender. Usually, credit cards, department store cards, and other similar debts are unsecured because they are not tied up to any property.

How does your type of debt affect bankruptcy? If you're filing Chapter 7 Bankruptcy, the borrower has the option to choose whether he wants to keep his property and pay his creditors instead or surrender his property as payment for his debts.

In Chapter 13 Bankruptcy, the borrower is allowed to keep his property provided that he agrees to pay back all his debts to his creditors. The borrower will then be subjected to new payment terms that will be arrange by his lender. The bankruptcy court allows lenders to charge up to a 10% interest rate to give the borrower the chance to pay back more easily. If the borrower was paying a 15% interest on his loan before filing for bankruptcy, the 5% less interest will be a tremendous ease to his load. Moreover, if the borrower's debts are less than the value of the property he submitted as security, he has the option to make repayments without any interest.

With an unsecured debt, if an individual has already filed for bankruptcy, the creditor will have to stop all its attempts to collect debts from the borrower as the ordered by the bankruptcy court.

In some cases, the lender can file a petition to the bankruptcy court if there is any dispute about the type of debt owed. If the bankruptcy court denies this petition and declares that the debts are unsecured, the lender must stop taking any action against the borrower. If the lender violates this rule, he will be facing punishment from the bankruptcy court.

Clearly, understanding the type of your debts plays is very important. As the borrower, it protects you from any violation from your lenders and it knowing what your options are, will enable you to decide more efficiently with regards to your debts especially when financial difficulties arise.

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