I was speaking with a potential client yesterday and I was asking the person whether they had any secured debts. They didn’t know how to respond and it dawned on me that others might not know the difference between a “secured” debt and an “unsecured” debt.

In short, a “secured” debt is a debt that is “secured” by collateral. A secured creditor has the right to repossess a piece of property in the event of a payment default. The most common examples of “secured” debts are mortgages and car loans. Most people realize that a car can be repossessed if they fall behind on their car payments, but they don’t always realize that type of debt is a “secured” debt.

Other types of “secured” debt are in-store financing for furniture, electronics, etc… In-store financing includes a store credit card, like a Best Buy, Circuit City, HH Gregg card, etc… Title loans on vehicles and financing companies that ask for a household good listing are also “secured” debt.

“Unsecured” debt, therefore, is debt that is not secured by any collateral. Typical “unsecured” debts include medical bills, VISA, Mastercard, American Express, or other types of credit cards (other than store cards which are technically “secured”) and personal loans (loans that don’t require you to give a list of household goods as collateral).

The general rule in Chapter 7 bankruptcy is that you must pay for what you want to keep. If you want to keep your car, keep making the payments. If you want to keep your furniture, generally, you must keep paying that creditor. So, if you owe “secured” debt and you want to retain the collateral, the general rule is that you must pay these creditors. In bankruptcy it is sometimes possible to negotiate better terms with the secured creditor. This negotiation process and agreement is referred to in the bankruptcy court as a “reaffirmation.” “Secured” debts also get better treatment in Chapter 13 repayment plans because the law requires that a Chapter 13 plan must repay the “value” of the collateral + interest and then the “unsecured” portion of the claim gets treated as a general “unsecured” debt and can be paid pennies on the dollar.

“Unsecured” debts get discharged in bankruptcy without risking repossession of any property. “Unsecured” debts in Chapter 13 are typically paid at only pennies on a dollar.

I want to give you all an idea of the bankruptcy process. I’ll try to keep this simple and cover only the “normal” case and not cases involving objections from creditors and other complications.

Once you’ve chosen an attorney, provided all the documentation requested and paid the required fees, it’s time to file your case. If you are in a Chapter 7 case, then the procedure is the case gets filed with the Clerk’s office in your jurisdiction. Upon the filing, an automatic stay goes into effect. This stay immediately stops your creditors from doing any collection proceedings, including court-ordered garnishments, license suspensions, phone calls, billings, etc…

About 4-6 weeks after your case is filed, you will have to attend a “meeting of creditors” or “Section 341″ meeting. This is a hearing that debtors are required to attend. Typically, if you’ve hired a full-service bankruptcy law firm such as ours, an attorney will be at your hearing with you. An interim trustee appointed by the US Trustee’s Office convenes and presides over the hearing, not a judge. This hearing is a time for the trustee to verify the information on your bankruptcy paperwork. The interim trustee’s job is to liquidate any non-exempt assets (assets you own that cannot be protected from creditors pursuant to state or federal exemption law - please make sure you consult with an attorney) and to screen for fraud. If you have a good lawyer, the questions won’t come as a surprise. The hearing is typically about 5 minutes long.

Once the hearing is concluded, creditors have under the Bankruptcy Code 60 days to file objections to the discharge if the creditor can establish that the debt to it should not be discharged (again, consult with experienced counsel to discuss your specific situation and the attorney should be able to warn you about any potential dischargeability issues before you even decide to file your case). Assuming neither the trustee or the creditors file an objection to discharge, the bankruptcy clerk’s office will then issue a discharge. Most clerk’s offices issue discharges about 2 weeks after the 60 day deadline for objecting to discharge has expired.

Thus, from the time the case is filed until the time the case is discharged is roughly about 3 1/2 months.

There are some things that could happen that will postpone the discharge. If the trustee or creditor objects to discharge, or if a party seeks an extension of time because it wants to do more investigation, then the discharge will be delayed.

Usually the discharge is the end of the case and the bankruptcy clerk then “closes” the case. However, if the trustee has to sell some non-exempt assets (see above and speak with experienced counsel about this) then the case isn’t over because the trustee is give time to collect property, sell property, set deadlines for creditors to file claims (creditors must file a claim if they want to share some of the money collected by the trustee) and distribute money to creditors on a pro rata basis.

In a Chapter 13 case, the procedure is much the same in that there is a “meeting of creditors” about 4-6 weeks after the case is filed. However, Chapter 13’s require a “confirmation” hearing after the meeting of creditors. This is where the Judge will either accept the plan or reject the plan. If the Judge accepts the plan (meaning that in the judge’s opinion the plan complies with bankruptcy law), then the debtor just needs to make the plan payments and once the payments are complete (typically 3-5 years, depending on the terms of the plan), then the court will issue a discharge. So, discharge in Chapter 13 typically occurs 3-5 years down the line.

Creditors can object to confirmation, as can the trustee. If a creditor feels the repayment plan is not paying them a sufficient amount of money, then the creditor can object to confirmation of the plan. Usually the debtor and the complaining creditor resolve the dispute and amend documents to make the creditor happy. However, if the parties can’t resolve the dispute, the Judge will rule on the objection either denying the objection and confirming the plan, or sustaining the objection and denying confirmation. If confirmation is denied, then the Trustee will ask the Court to dismiss the case. Denial of confirmation is grounds for dismissal. If the plan is “confirmed” then as above, the debtor just needs to make the plan payments and once the plan is complete, the case will be discharged.

Remember, this is basic information and there can be things that happen during both Chapter 7 and Chapter 13 that I haven’t covered here, but I wanted to just give an overview of the important steps in the bankruptcy process.

A lot of debtors my firm represents owe money on student loans. Currently Section 523(a)(8) of the Bankruptcy Code provides an exception to discharge (meaning the debt will not go away after bankruptcy) “for an educational benefit overpayment or loan made, insured or guaranteed by a governmental unit, or made under any program funded in whole or in part by a governmental unit or nonprofit institution, or for an obligation to repay funds received as an educational benefit, scholarship or stipend, unless excepting such debt from discharge under this paragraph will impose an undue hardship on the debtor and the debtor’s dependents;”

Basically this means that the only types of debts incurred for educational benefits that will go away in bankruptcy are debts owed to a “for profit” institution or when the debtor can establish “undue hardship.”

Some examples of “for profit” institutions I’ve seen from some past cases include, beauty schools, DeVry Institute of Technology, and truck driving schools.

The term “undue hardship” seems simple enough, but the way courts have interpreted that varies across the country. While most cases cite the same basic factors courts review to determine dischargeability of student loans, the application of those factors vary widely. Usually I advise debtors that unless they have some sort of permanent disability and have tried to make payments on their student loans for a period of time, it’s not worth their money to pay me to litigate against the government or institution about this issue. As a practical matter, it can cost a lot of money to litigate because most litigation is billed at an attorney’s hourly rate. The costs of litigation therefore depends on how aggressive the governmental entity or institution is going to be in defending the adversary. Usually a debtor who needs an “undue hardship” can’t afford to litigate the issue. Of course, there are some cases that my firm has agreed to do pro bono (for free), but being in a private business without any funding from the government limits the feasibility of representing people for free, especially in time consuming litigation.

Under the new bankruptcy legislation, it will no longer matter whether the loan you owe is to a governmental unit or a nonprofit institution. Any debt incurred for an educational benefit will not be discharged in bankruptcy. Thus, I can no longer advise debtors that I can eliminate their beauty school loans or truck driving school loans. Under the new legislation the only grounds to discharge a student loan involve the debtor’s showing of an “undue hardship.”

The good news is that even though most student loans survive bankruptcy, repaying those loans is an excellent way to re-establish and rebuild a credit rating after bankruptcy. Ideally, eliminating all of your other debt frees up money from your budget to be able to afford to pay back student loans. Student loan interest is typically much lower than interest rates on most other unsecured loans, so usually you can have a pretty high balance on the student loans and still have a reasonably low payment. There are also a lot of consolidation programs out there that allow a debtor to spread out student loan repayment over a long period of time, further lowering the monthly payment. Even if you’ve defaulted on a student loan in the past, if you can make 6 consecutive monthly payments, even if you are still technically in default, you are eligible for rehabilitation programs through the loan servicing agency. Once your loan is “rehabilitated” you can later qualify for consolidation programs.

The bad news about student loans is that generally they aren’t going to go away in bankruptcy. The good news is that repaying them helps rebuild your credit and you’re able to rebuild your credit by paying back loans that are at very low interest rates. Of course, if you truly feel repaying your student loans imposes an “undue hardship” on you, you should definitely discuss the possibility of an adversary proceeding to discharge them in bankruptcy directly with an experienced bankruptcy attorney in your geographic area.

More info about student loans and bankruptcy.