Secured vs. Unsecured Debts
Secured debts are those that a creditor has secured a right in a debtor's property through a lien, as in the case of a car or home loan. The property being secured is often referred to as collateral. The creditor's security interest in the property ensures payment of the debt, so if the debtor fails to make payments as agreed, the creditor can take the property. For example, failure to make payments on a mortgage or car loan results in the foreclosure of the home or repossession of the vehicle. In contrast, unsecured debts, such as credit cards and personal loans, are not secured by any personal property.
A second mortgage, or junior lien, is a loan you take out on your property while the original loan, or primary mortgage, is still in place. Common examples include home equity lines of credit and home equity loans. As with the first loan, the home serves as collateral, making the second mortgage a secured debt. In the context of bankruptcy, your second mortgage holds a secondary, or subordinate, position to your first mortgage. This means that if your home is sold to pay off your mortgage or other debts, the original mortgage lender receives payment first. In the event there are not enough funds to pay both mortgages, some or all of the second mortgage may go unpaid. In other words, it will be treated as an unsecured debt.
Chapter 7 vs. Chapter 13
If you fall behind on your second mortgage payments, you might file either Chapter 7 or Chapter 13 bankruptcy. Chapter 7 bankruptcy requires you to give up all of your nonexempt assets to pay your creditors. On the other hand, Chapter 13 lets you hold on to your assets; you enter into a repayment plan and pay some or all of your debts over a three- to five-year period. Chapter 13 requires all secured debts to be paid by the plan, which means these debts take priority. If you are behind on your second mortgage, you would be required to bring this loan current before you receive a discharge at the end of the repayment plan. However, if your second loan exceeds the value of your home, it can be "stripped" by the court, meaning it will be turned into an unsecured debt, and you may not be required to pay it in full, or at all.
If you want to keep your home despite filing for bankruptcy, you have two options available to you. With Chapters 7 and 13, you can either give up your home or reaffirm the second mortgage. Reaffirmation of a loan, a legally binding agreement, allows you to waive the right to discharge the mortgage in bankruptcy by promising to pay the debt. Not all creditors accept reaffirmation, especially if you are badly in arrears. With a reaffirmation agreement in place, however, you continue to make mortgage payments during the bankruptcy and after. If you subsequently fall behind, you will not be able to discharge this debt, and the lender can take legal action against you.