Secured Debt Treated Like Unsecured Debt after Collateral Surrender

 Posted on April 30, 2025 in Secured Debts

One of the most painful and stressful things about bankruptcy is having to surrender your assets. Whether they include real estate, a vehicle, or other secured debts, surrendering assets to creditors can be difficult emotionally and practically. But what if surrendering collateral could be a positive thing in bankruptcy? In some instances, surrendering collateral rather than keeping the asset can actually be beneficial and may make more sense than you might initially think, as it can help you afford payments on other important assets and give you a chance to discharge that debt. That is true because when you surrender your collateral, your secured debt is treated as unsecured debt–and that makes a big difference in bankruptcy. An experienced Boerne, TX bankruptcy attorney can advise you on whether surrendering collateral to turn secured debt into unsecured debt makes sense in your case.

How Do "General Unsecured" Debts and Secured Debts Work in Bankruptcy?

Any remaining balance after surrendering the collateral is treated as an unsecured claim in bankruptcy. "General unsecured" debts are discharged, which means they are legally and permanently written off. With secured debts, you are personally liable for the loan and the lien. The lien that the creditor has on something you own is not usually affected in bankruptcy. It continues in effect, giving the creditor continued rights to your asset after the bankruptcy case is completed, and this typically includes the right to repossess or foreclose. So if you want to keep that asset, you usually have to pay the debt. However, you can effectively turn a secured debt into a general unsecured debt in bankruptcy. One of the most potentially powerful tools you have is to surrender your asset–the collateral on your debt–to the creditor.

How Can Surrendering the Asset Help You in Bankruptcy? 

Why would you want to turn a secured debt into a general unsecured debt and lose an asset? Simply giving the asset that a creditor has a lien to that creditor essentially turns the debt into an unsecured one, as noted above. That means that as far as you are concerned, the debt is no longer secured. This can be a good thing because now the creditor no longer has a lien on anything you own, and therefore has no leverage over you. You can now discharge the debt in Chapter 7 and pay nothing on it.

When Should You Surrender the Asset to the Creditor?

There are several circumstances under which your best option may be to give your asset to the creditor. Some of these include:

You Cannot Afford the Payments

It is worth taking a very honest look at how much filing for bankruptcy will help your monthly cash flow. You may need bankruptcy relief to deal with unbearable debt pressures. And the minute you file your case, you most likely will be able to stop paying many of your monthly debts. That may free up money so you can then comfortably pay off your vehicle loan or home mortgage.

But be careful. Especially if you have not paid many of your debts for a while, filing bankruptcy may not free up as much disposable income as you may think. Pay close attention when your bankruptcy lawyer helps you put together a formal budget. There are various factors to consider, including those related to your individual income & individual expenses. Be honest with yourself about whether you will be able to afford to make the secured debt payments. If this might not be feasible, you must seriously consider whether surrendering the vehicle or home and owing nothing is your better choice.

You Are behind on the Payments and Filing a Chapter 13 Case Is Not Worthwhile

If you have fallen behind on your car loan or home mortgage, you usually have very little time to catch up in a Chapter 7 "straight bankruptcy" case. Chapter 13 "adjustment of debts" gives you much more time, often as much as five years. But consider carefully whether keeping the vehicle or home is worth the downsides of a Chapter 13 case.

For various reasons, Chapter 13 cases have a much lower successful completion rate than Chapter 7 ones. You might struggle to fulfill the obligations of your Chapter 13 payment plan for several years, only to end up not succeeding. At that point, you may have to surrender your home or vehicle after all. Alternately, you may need to convert your case into a Chapter 7 bankruptcy, after a great deal of wasted effort. In the meantime, you have made little or no progress on improving your credit score. More importantly, you have delayed the fresh financial start that you need.

So you should use Chapter 13 to cure your financial distress when you must. But avoid it if it is likely to cause further financial trouble.

Even if You Are Not behind or Can Catch Up Fast, It Is Just Not Economically Worth Keeping the Asset

There is more to life than economic calculations. Sometimes there are valid intangible reasons to keep fighting hard to keep a vehicle or a home even if it has no equity. Your car may be worth much more to you than some generic "blue book" dollar amount. Likewise, the stability of a home can have a massive positive impact on yourself, your marriage, or your kids, which can result in major value for you.

On the other hand, be very careful about putting too much weight on these kinds of intangibles. A sensible rule of thumb to think about is whether you can honestly and dispassionately consider the option of surrender. If you refuse to even consider other alternatives, that is a warning sign that you might not be considering everything reasonably. If it is very clearly a financially bad idea to sink more money and time into something, you need to at least consider other options.

It Might Be Risky Down the Line to Keep the Asset, so Taking Advantage of Your Right to Discharge the Debt Now Can Be Smart

Especially with vehicles, you often have a virtual once-in-a-lifetime opportunity to get out of a bad loan when you file a Chapter 7 bankruptcy case. You typically must "reaffirm" the debt if you want to keep the car. That means that you legally exclude the car loan from the discharge of your other debts. You have to choose one or the other: surrender the vehicle and discharge the debt, or keep it and do not discharge the debt.

If you keep the vehicle and reaffirm the loan, and then months or even years later you cannot make the payments and the vehicle is repossessed, you could easily end up owing a lot of money. You would have no vehicle and you would still owe the money. As a result, months or years after your Chapter 7 case you would be in financial trouble again. So carefully consider whether you will be able to keep up payments on a secured debt in the long run. Think about whether it is wiser to surrender the vehicle, home, or other collateral and get a fresh start now.

Are There Disadvantages to Surrendering Your Assets in Bankruptcy? 

Certainly, losing the house or car can be a disadvantage, especially if you cannot afford rent payments or do not have viable public transportation options where you live. This is not something to be taken lightly.

Another potential disadvantage to consider relates to filing for Chapter 7 bankruptcy. Some courts will not allow you to count your loan payments on property that you will surrender for purposes of the means test. The means test is an income test that you must pass to file for Chapter 7 bankruptcy. If you have a bigger income, you may need the secured payments to reduce the amount of disposable income you have to qualify for Chapter 7 bankruptcy, so this is something to keep in mind.

Schedule a Free Consultation with a Boerne, TX Bankruptcy Attorney 

The decision to file for bankruptcy can be a difficult one to make. It can also be difficult to surrender certain assets once you file bankruptcy. An experienced Kerrville, TX bankruptcy attorney can review your case and advise you on whether it might still be the wisest choice for you. At the Law Offices of Chance M. McGhee, attorney Chance McGhee has the skills and experience to steer your bankruptcy case. Call the firm at 210-342-3400 for a complimentary consultation.