What is the Difference Between Secured and Unsecured Debt?

Bankruptcy courts discriminate between so-called secured and unsecured debt. How do the courts construe these categories? Secured debt is money owed to a creditor that's backed up by either a piece of real estate or another kind of property. With a home mortgage, for instance, the mortgage loan is backed up by the house. Another type of secured debt is called a mechanics lien, in which a piece of real estate or other property provides the collateral for a loan. An unsecured debt, on the other hand, is a debt that's not tied to any piece of property or real estate.

How do these distinctions matter when it comes to adjudicating bankruptcy situations? During Chapter 7, a court may put a stay on the collection of unsecured debts while at the same time allow creditors of secured debts to pursue remedies. A secured creditor, for instance, may take action to foreclose on a piece of a property, seize a car or a work related tool, or attempt to garnish or gain entirely the equity leftover in a piece of the collateral.

Unsecured creditors often must “pick a number” and hope that the bankruptcy trustee doles out enough money to them through the liquidation and proceeds of the debtor's estate to cover the amount of the debt. The rules governing which unsecured debts get paid off first by the trustee are complicated, but priority unsecured debts often take precedent over general debts, such as cash advance loans, medical bills, and unsecured credit card debt.

In the event that a secured creditor discovers that his or her loan is unsecured, he or she may petition the court for redress, despite the bankruptcy proceedings. That said, if the court denies said move, and creditors continue to file motions, take legal action, send notices or make phone calls to the debtor, the bankruptcy court can punish a creditor and void all legal moves made to get the debt paid after the bankruptcy court officiated automatic stay. In some extraordinary cases, secured creditors may end up abrogating some or all of the rights that they have to a given property if they pursue prohibited actions which have not been sanctified by the bankruptcy court to retrieve moneys.