Bankruptcy gives you a fresh financial start. It also provides the fairest payday for your creditors. Some debts get treated better than others, though. One class of debts receiving special treatment is secured claims.

If you're thinking about filing for bankruptcy, you should know how any secured claims against your property will be treated. It may make a difference in whether or not bankruptcy is right for you.

Security Interests and Secured Claims

Secured claims are debts backed up by security interests in property. A security interest is a lien on property. It's a right a creditor has to collect a debt out of specific property.

Take a car loan for example. Your lender takes a security interest in the car you buy as part of the loan agreement. If you don't make your payments, the lender can repossess the car and sell it to repay the debt. This right also puts the lender ahead in line of anybody else you may owe money to and wants a share of the sales proceeds, so it's very valuable.

The same is true if you file bankruptcy. A key part of your case is sorting out which creditors will be paid and how much. Creditors with secured claims fare better and are paid ahead of unsecured creditors, such as credit card accounts.

It's important for you, too. As a general rule, you either have to pay the debt or give the property back to the secured creditor.

All Kinds of Security Interests

Consensual Liens

There are several types of security interests but they all work the same way as the car loan. For example, a mortgage or deed of trust on your home or other real property gives the lender the right to be repaid from the property. These are called consensual liens, because you agreed to give the creditor the security interest, or lien, when getting the loan.

Another type of consensual lien is the purchase money security interest (PMSI). A PMSI usually is connected to seller-financed purchases. Purchases made with an in-store credit card are covered with a PMSI in the property - appliances and furniture are good examples. But, if you buy the same property with a bank credit card, there's usually no PMSI.

Judgment Liens

A judgment lien comes from a court judgment. A creditor has to go one step further to turn a judgment into a lien. This is called perfecting the lien. The laws in your state set the rules for perfecting judgment liens. The creditor usually gets a lien on property belonging to you by recording the judgment in the city or county where the property is located. A lien may also be filed with your Secretary of State's office.

There can be more than one lien on the same item of property. The general rule is "first in time, first in right." That is, earlier liens trump later ones.

Tax Liens

The IRS and state and local taxing authorities generally get an automatic lien for taxes due and unpaid. A tax lien creates a lien on all of your real estate and personal property. Generally, they get special treatment and might be paid out of your savings and 401(k) plans normal creditors can't reach.

In bankruptcy, you may be able to have tax liens discharged if you file under Chapter 7. If you file under Chapter 13, you generally repay your tax bill during your repayment plan.

Blanket Security Interests

Most secured bank loans and all Small Business Administration (SBA) loans give the lender a security interest in all of your personal property. This blanket security interest doesn't cover land, but it may cover equipment, accounts receivable and patents or trademarks. Practically anything of value can be covered by a blanket security interest.

The security agreement usually also covers all property you buy or acquire before the loan is paid off and the security interest is released or ends.

Other Important Things About Secured Claims

Secured claims receive priority of payment in bankruptcy, meaning they're at the top of the list of items to be paid if any of your property is sold by the bankruptcy trustee to pay your creditors. This is another reason why the lien is so important.

Also, when it comes to exemptions, not all secured claims are alike. You may be able to avoid or get around some types of liens if they prevent you from using an exemption. For example, you may be able to avoid or cancel a judicial lien against your home because it interferes with your right to claim an exemption in your home (the homestead exemption).

You also need to classify debts as secured or unsecured to figure out if you're eligible for Chapter 13 reorganization. In Chapter 13 some liens can be "stripped down" to the value of the property. If a lien is more than the property's value, the excess amount becomes an unsecured claim. That means the creditor may get paid only cents on the dollar, if at all.

Keep in mind, too, that liens continue in any proceeds from the sale of the asset. If there's a lien on your car and you sell it, the lender has the right to payment of the debt from the cash you got. If you fritter the money away or even pay other debts with it, the creditor may still file a secured claim against you in bankruptcy.

While you're thinking about filing bankruptcy, think about the secured claims creditors may have against your property. Talk to your attorney about these claims to see if bankruptcy will protect your property the way you want it to.

Questions for Your Attorney

• How do I know if a debt is secured?
• Does a security interest trump even my exemption in property?
• Does a secured debt remain after bankruptcy?

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