How is Unsecured Debt Treated in a Bankruptcy?

There is no hard and fast rule to determine how much of your unsecured debt will be removed or “discharged” when you file for bankruptcy. If you opt for Chapter 7, you can clear your credit within as little as three months.

If you manage a secured Chapter 13 bankruptcy, on the other hand, you may still have to deal with some forms of unsecured debt for years. That said, Chapter 7 isn't necessarily preferable to Chapter 13 -- your income situation, creditor relationships, state laws, and long-term financial risk strategy should all come into play when calculating the best way to manage unsecured debt with bankruptcy.

What kinds of unsecured debts exist? Medical bills and past due notices -- such as obligations to your health insurance company -- may be considered unsecured debt and wiped clean by bankruptcy. Similarly, auto loans, loans for machinery or tools of trade, mortgage payments, credit card payments, payday loan obligations, and loans to family and friends that aren't explicitly defined within other contexts can also be considered by the court to be unsecured debt.

Your trustee will likely break down your creditors into priority versus general lenders. Priority unsecured issuers will be the first in line to collect remuneration from the liquidation of your estate and assets. In some cases, where the debtor's estate doesn't have much money, unsecured lenders may wind up with little to nothing -- particularly if they are classified as “general unsecured.”

There are limits to the resolution of unsecured debt problems. For instance, if you have child support or alimony payments, and you try to transfer these debts to a credit card -- particularly in the run-up to a bankruptcy filing -- the courts will disallow the discharge.

Moreover, if you try to “pull one over” on the bankruptcy courts by, for instance, trying to get your past due income taxes eliminated by artificially concealing them as unsecured debt, innumerable legal problems could result -- potentially trashing your bankruptcy filing and landing you in a lot of legal hot water. Talk to your bankruptcy lawyer to determine what you may claim as unsecured debt so that you can petition the court effectively and line up your financial resources in preparation for post-bankruptcy planning.