Which of the two consumer bankruptcy Chapters is better for you if you owe a lot of unsecured debts depends on the kind of unsecured debts.
Debts that are unsecured are those which are not secured by anything you own. The creditor has no “security interest” in anything, no right to repossess anything if you don’t pay the debt.
In general it’s easier to deal with unsecured debt than secured ones in bankruptcy.
Unsecured Debts Turning into Secured Ones
Unsecured debts can turn into secured ones if you don’t pay them. A credit card holder or medical provider can sue you for the balance owed, get a judgment against you, and usually can record that judgment as a lien against your home and other possessions. If you don’t pay your federal income taxes the IRS can record a tax lien against your real estate and personal property without suing you.
Under some circumstances bankruptcy can turn an unsecured debt that had been turned into a secured one by the creditor back into an unsecured one. But not always. For example, an older income tax debt that could have been completely “discharged”—written off without paying anything—may have to be paid in full once a tax lien was recorded on it. So in general it’s better to file a bankruptcy case before creditors can turn unsecured debts into secured ones.
Secured Debts Turning into Unsecured Ones
When a secured creditor repossesses or forecloses on something you own, and sells it and credits the sale proceeds against your balance, if there’s still a remaining debt it is now unsecured.
“Priority” and “General Unsecured” Debts
There are two broad kinds of unsecured debts.
“Priority” debts are those that the law treats as special because of different “policy” reasons for treating that particular kind of debt more favorably. For example, unpaid child support and income taxes are “priority” debts. Congress has determined that bankruptcy should not be able to discharge child support or hinder its collection because of the high value Congress places on the payment of child support. And income taxes are considered a social obligation that we should not be able to avoid easily. And yet income taxes can be discharged if they are old enough and meet some other conditions.
“General unsecured” debts are simply unsecured debts that do not fit into any of the “priority” debt categories. “General unsecured” debts include most unsecured ones, such as medical and credit card debts, retail accounts, personal loans, many payday and internet loans, unpaid utilities and other bills, claims against you arising out of vehicle accidents other injuries, and out of contractual and business disputes, overdrawn checking accounts, bounced checks, the remaining debt after a vehicle repossession or real estate foreclosure, many kinds of debts from operating a business, and on and on.
Chapter 7 vs. Chapter 13
Speaking very broadly, if all your unsecured debts are “general unsecured” and are not “priority” ones, you’d lean towards filing a Chapter 7 “straight bankruptcy” case.
That’s because it usually discharges (writes off) those debts quickly, in a matter of 3 or 4 months, and almost always without you needing to pay anything on those debts.
In contrast, in a Chapter 13 “adjustment of debts” case you would usually have to pay some portion of your “general unsecured” debts (although in some situations you may not pay anything). Also, the discharge of the remaining unpaid portion would not happen until the end of the 3-to-5-year payment plan. And maybe most important, if you do not successfully complete the Chapter 13 case—which have a much lower percent completion rate than Chapter 7 cases—that remaining portion of the “general unsecured” debts would not be discharged at all and you’d continue owing them.
On the other hand, again speaking very broadly, if you have a “priority” debt or more than one of them, and especially if that debt or those debts are large, you may lean towards filing a Chapter 13 case. That’s because it has better tools for dealing with “priority” debts than Chapter 7.
In the next few blog posts we’ll look at the various kinds of “priority” debts to see how each is handled under Chapter 7 and Chapter 13. In particular we’ll look at circumstances in which each kind of “priority” debt can be appropriately handled in a Chapter 7 case vs. when that kind of “priority” debt needs the extra help of Chapter 13.