In law, things are not always what one might think they should be.   

To non-attorneys, it sometimes must seem like what Alice (of Wonderland fame) saw through the looking glass.

A common source of confusion among my bankruptcy clients relates to what happens to secured debts that have liens against property owned by the debtor filing bankruptcy after a discharge of debts is granted.

Mortgage and Other Secured Debts Will be Discharged

A while back I discussed which debts are dischargeable in bankruptcy.

Mortgage debts, and other secured debts–such as those on vehicles–are also dischargeable in bankruptcy in most cases.   This means that the obligation to pay on the underlying mortgage (or other secured) debt is extinguished if you receive a discharge in bankruptcy.

“What?” you say.  “Does this mean I don’t have to pay my mortgage or car payments anymore?”

You Must Keep Making Payments if You Want to Keep Your House or Other Secured Assets

You do not have to pay them if you choose not to keep the asset (home, car, etc.).  However, if you want to keep the property, you must stay current with payments (and, in the case of certain vehicle lenders, you also may need to enter into a reaffirmation agreement to prevent repossession).  Reaffirmations remove the debt from bankruptcy and make it non-dischargeable.

A Lien is Not a Debt and a Debt is Not a Lien

The reason people get confused by this is a misunderstanding (or lack of awareness of)  the difference between a debt and a lien.  They are very different animals.

For example, a mortgage is a consensual (voluntary) lien which is secured by collateral (usually the property on which the mortgage loan was given) for the amount owed on the loan (debt).   Similarly with vehicles, for example:  The debt owed to the vehicle lender is usually secured by the vehicle, thereby creating a lien.

Bankruptcy Discharge Eliminates Personal Liability on Debts, Not Liens

Here’s the legal explanation:  From a purely legal standpoint (and there’s just no way to make this simpler), a bankruptcy discharge removes the ability of creditors to seek to collect against the debtor individually (known as in personam liability).  Liens, on the other hand, are in rem meaning they are rights against property.

There are ways to remove certain types of liens in bankruptcy, but they are NOT automatic and are limited.

For example:

  • In Chapter 11 and 13 cases,  voluntary (meaning, you agreed to it) junior mortgage liens can be removed if the value of the property is less than that owed to senior liens. See more on Consensual Mortgage Lien Avoidance 
  • Judgment liens can be removed if they impair an exemption to which the debtor is entitled on the date the case is filed. See more on Bankruptcy Judgement Lien Avoidance

Thus, in a typical case, debts owed to mortgages and vehicles will be discharged.  What this means is that in the event you stop making payments and the creditor forecloses or repossesses its collateral, or it is otherwise sold, you will owe nothing further.

But as long as you remain current with required payments, you can retain use of the collateral (again with the limited exception of the vehicles listed above).

So, when you understand how liens work, it makes more sense and less like the Mad Hatter himself was writing the laws.