One of the most powerful tools in the bankruptcy arsenal is the automatic stay—an injunction that arises when a bankruptcy is filed. It is so powerful that it prohibits almost all attempts by creditors to collect almost any kind of debt, including attempts to repossess cars and foreclose on home mortgages.
Handling Secured Debts in a Bankruptcy Case
Secured debt is debt for which you pledged collateral, like a car or a house. If you owe past-due car or house payments when you file bankruptcy, it is important to understand that bankruptcy does not give you a free ride on your secured debt. If you want to keep the collateral, you have to pay the lender at least what the collateral is worth, regardless of whether you file a Chapter 7 straight bankruptcy, a Chapter 13 payment plan case, or a Chapter 11 reorganization.
In a Chapter 7 case, unless you surrender the collateral, you either will redeem the collateral for its value or you will reaffirm the contract you originally signed. To redeem the collateral, you pay the creditor the value of the collateral, usually in one lump sum, rather than continuing the contract you originally signed. When you reaffirm the contract, you agree to take the contract out of the bankruptcy process and forgo the discharge on that particular debt. You then continue making the payments under the original contract. If you fail to make those payments, the creditor can repossess the vehicle after the bankruptcy case concludes and potentially sue you for any deficiency balance after the car is sold.
In a Chapter 13 case, you continue to make payments on your secured debt either as a part of the payment you make through the court or directly to the creditor.
Getting Around the Automatic Stay
Sometimes, especially in Chapter 13 cases, a debtor will stop making payments on a secured debt. A creditor can suffer undue hardship as the collateral declines in value if it had to wait until the end of a three- to five-year Chapter 13 plan before it could act. Instead, the bankruptcy code gives the creditor an option to file a motion with the bankruptcy court to remove the automatic stay and allow it to repossess or foreclose.
Creditors must show the court that you have no equity in the collateral and that you do not need it to have a successful Chapter 13 case or to reorganize your debt.
Such motions are less common in Chapter 7 cases because of the limited time they are open—usually less than six months. In that case, if you are not making your payments, your creditor will likely elect to wait until the case is closed, after which it will be free to repossess or foreclose.
Catch-Up Agreements and Drop-Dead Clauses
Even if you get behind while you are in bankruptcy, you still can avoid losing your collateral. Lenders typically prefer to have the money over the collateral and are willing to work a deal to get you caught up. In many jurisdictions, courts allow creditors and debtors to enter into agreements that contain a schedule of payments designed to bring an account current. Three to six months is a typical time frame. These deals almost always contain a drop-dead provision that the automatic stay will dissolve or lift if you fail to make payments or you otherwise put the collateral in jeopardy, like allowing insurance to lapse. That way, lenders can repossess or foreclose without having to file yet another motion.
While such agreements can be a lifesaver if you have suffered a temporary setback, the catch-up amount will include the cost that the creditor incurred to bring the motion, including attorney's fees and court costs, which can add as much as $1,000 to what you owe.