What debts will bankruptcy discharge?

Bankruptcy discharges unsecured debt like credit card and medical bills; some unsecured debt, like student loans, recent taxes and domestic support are not forgiven in bankruptcy. Bankruptcy also discharges secured debts like car loans and mortgages. However the liens or security interests remain attached to the properties.

Yet, in a chapter 13 bankruptcy, you can re-define secured debts in full or in part as unsecured debts. This is accomplished when secured debts are no longer secured by any value in the property as a result of depreciation. Thus, you can reduce the principal owed on car loans to the current market value (i.e. the secured portion of the loan), though you can only do this if the car was purchased more than 910 days prior to filing. The remainder of the loan is considered unsecured and can be discharged in bankruptcy even if it’s not paid for. In a chapter 13 bankruptcy, you can also discharge second mortgages, if they are entirely unsecured due to depreciation.

Acquiring a secured debt entails the recording of a lien on your property. Your lien eats up your ownership interest and it remains stuck to the property unless the underlying debt is paid off. However, when depreciation occurs, there may no longer be value in the property to support the lien. That renders it unsecured in nature and thus dischargeable. For example, a second mortgage is a secured debt. However, if you file a chapter 13 bankruptcy, you can “strip off” a second mortgage if the value of the home doesn’t exceed the balance on the first mortgage. The strip-off converts or changes the second mortgage into unsecured debt. As unsecured debt, it can be fully discharged in bankruptcyeven if it’s not paid for in full.

If you have a judgment lien on your home, you can avoid (remove) it in bankruptcy if there is no value to secure it after you apply mortgage interests and and exempt the amount of equity you’re allowed to keep. Through avoidance, the judgment lien becomes an unsecured debt that is dischargeable in bankruptcy. Consider Courtney, the cosmetician’s condo in Coronado. The condo’s worth $225K and Courtney owes $150K on it to the bank. Courtney is sued by frivolous Farrah for five facials gone bad to the tune of $50K. Farrah wins her suit and a $50K judgment lien attaches to the condo. Courtney files for chapter 7 bankruptcy protection; she can exempt (protect from liquidation) her $75K of equity in the condo (as of a 2010 increase in the exemption amount). Of the condo’s $225K value, $150K belongs to the bank and $75K belongs to Courtney. There’s nothing left to secure the judgment lien. Farrah’s lien can be avoided and discharged through bankruptcy. A special motion must be made to the court to avoid liens; it is not accomplished automatically through a bankruptcy petition.

Bankruptcy will not discharge debt arising from willful malice, fraud, theft, drunk driving or breach of fiduciary duty. Both the United States Trustee and creditors can attempt to prevent bankruptcy discharge based upon the above allegations.

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