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Types of Debt

It is important to understand that creditors you owe money to are classified into several categories. Depending on the "class" of the creditor will depend on what they can actually do to you if you default on your payments to them. Here is a general overview, in simple terms, of the two most common types of creditors that you will most likely deal with:

Secured Creditor - A secured creditor is someone that you borrowed money from and in exchange for the loan you gave them some type of collateral to secure the loan with. The 2 most common secured loans would be your mortgage and auto loan. If you fail to make the payments to these creditors, they have a right to take back the property to help "offset" the loan.

For Example: If you took out a home loan and borrowed $250,000, you agreed to pay the lender back the $250,000. When you got the loan, you agreed that the house would be used as collateral. If you miss your payments, the lender can take the home. The lender will usually give you a Notice of Default (saying that you defaulted on your payments) and will then proceed with a foreclosure sale. What this basically means is that the lender is going to attempt to auction the house off to a highest bidder. They want to try and get as much money as possible from the auction to help them get back the $250,000 that they lent. Notice of Default requirements and the Foreclosure process vary from State to State.

Now, if the lender does foreclose on the home and at the time of the foreclosure sale only receives $200,000 for the home, you would still owe $50,000 (the total of what you owed); this is called a deficiency balance. That deficiency balance is no longer secured by any property and the creditor is now an Unsecured Creditor (meaning that there is no collateral protecting the loan).

If you have more than 1 lender on your house, the same may apply. If the 2nd Trust Deed/Mortgage Holder is in default, they have to protect the interest of the 1st Trust Deed Holder - because they are in the First Position (they have priority - simply put, they were there first). If the 2nd Trust Deed holder wished to foreclose, normally, they would have to make sure that the 1st Trust Deed holder received what was owed to them at the time of the sale or they would have to assume that amount owed.

Now, if the 1st Trust Deed forecloses, they don’t have to worry about the 2nd. Either the 2nd has to step up to the plate and take care of the 1st or their security interest gets wiped out. You would still owe the 2nd their money, they just are no longer secured.

In the case of your Automobile loan - if you fail to make your required payments, the lender may attempt to repossess your vehicle, since that is the collateral that you gave as part of the condition of obtaining the loan. If this happens, the lender will sell the vehicle at auction. Usually, the lender will get pennies to the dollar for the vehicle. So, if you borrowed $12,000 on a vehicle and it was sold at auction for $5,000 - you would still owe the remaining balance of $7,000 but the lender is no longer a secured creditor. They move down to the unsecured creditors class.

Some other examples of Secured Creditors:

  • Loans obtain for Furniture
  • Some credit cards that are offered in connection with a motorcycle or skidoo purchase
  • Loans obtained for Boats

Unsecured Creditors: An unsecured creditor, if you have not figured it out by now, is a creditor that has agreed to lend you money but has taken no security interest or collateral in exchange of that loan. So, if you default on an unsecured obligation, that creditor must normally take you to Court and sue you in order to legally obtain (get) any money from you. Here are some examples of Unsecured Creditors - These are the types of debts that can be reasonably negotiated.

  • Credit Cards
  • Medical Bills
  • Retail Store Cards Cell Phone Bills
  • Personal Loans
  • Utility Bills
  • Rent Defaults
  • PayDay Loans
  • Non-Government Insured Student Loans

Some Quasi Unsecured Creditors: These creditors, while unsecured, have more protections/rights that they could pursue, if you default. In some cases, they do not necessarily have to obtain a Judgment against you in Court to make your life a bit uncomfortable. These are difficult to reach settlements on with any significant savings.

  • Court Ordered Child/Spousal Support
  • PayDay Loans
  • Timeshares
  • Criminal Fines/Penalties
  • Cash Call Accounts
  • Bank Overdraft Fees
  • Car Repair Bills
  • Attorney Fees
  • Sallie Mae Accounts
  • Gov. Insured/Backed Student Loans
  • Rent-To-Own
  • IRS/State Tax Owed

Some enforcement rights for these Quasi Unsecured Creditors are:

  • Court Ordered Child/Spousal Support - If you fail to make these payments, you could be forced by the Court to do so - you can even be put in jail for failure to pay. These debts are not dischargeable even in a Bankruptcy.

  • Car Repair Bills - Most times, when you take your vehicle to be worked on by a Mechanic - they usually have what is referred to as a "mechanics lien" - if you do not pay the bill, they have a right to keep the vehicle until the bill is paid - or they can auction the vehicle off to satisfy the bill - so it’s best to work something out.

  • Gov. Insured/Backed Student Loans - These loans have been guaranteed by the Government. If you default on these payments, the Government has a right to go after you for the money. This may include keeping any future tax refunds you may be entitled to. Attaching a lien against your property or levying your bank accounts. These debts are usually never dischargeable in a Bankruptcy and can quite frankly, follow you to your grave. There has been some talk in Congress to change this.

  • Bank Overdraft Fees - Most likely this type of debt, if not incurred fraudulently, will be turned over to a collection company and it will reflect negatively on your credit report. What a bank has as additional leverage against you is that they will report that debt in their "Check System" that all banking institutions use when you open a new account. You will find that, most likely, no bank will open you a new checking account until the debt is resolved.

  • Rent to Own - At a minimum, failing to pay may result in the forfeiture of all payments made and they will come to get the property that was being financed.

  • IRS/State Tax Owed - Although this is an unsecured debt, the IRS or State does not need to sue you in order to get their money. They can levy bank accounts and wages, place a lien on your house or other property. They can even force a sale of the home to get the money owed. It’s best to work out a payment plan or hire someone to negotiate a settlement on your behalf.

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