What Kinds of Debt Are There and What Does That Mean To Me?

Excerpted from Credit Smart by Gudrun Maria Nickel ©2003

Simply put, debt is owing money to someone else. However, there are many types of debt—each with its own legal and financial obligations. Understanding the various categories and types of loans available will strengthen your ability to better manage your own personal debt.

Secured Debt
All debts are either secured or unsecured. When an interest in property is given to your lender to make the loan safe, you have a secured debt. Examples of secured debt are your home mortgage and your car loan. The lender puts everyone on notice about its interest in your property by filing a mortgage on your real estate or a security interest in your personal property in the appropriate county or state records. The lender will secure its interest in a car or mobile home by placing its lien directly on the title.

Where the lender has taken the proper steps to record its interest, you cannot sell the property without either paying off the lender or having the buyer take the property subject to the lender’s interest. The property given as security is also referred to as collateral.

The lender may also take an interest in personal property by taking possession of it.

Unsecured Debt becoming Secured Debt
An unsecured debt may become a secured debt if a judgment becomes a lien (or claim) on your property. Even without judgments, some states allow liens to be filed. In Florida, for example, condominium associations generally have the right, without first getting a judgment, to place a lien on your property if you do not pay your condominium association assessments. Likewise, people that you employ to work on your property or provide material may be able to file a lien before getting a judgment if you do not pay them. A judgment may also become a lien on your property. Ultimately, the lienholder may take the property and foreclose its lien, just like a creditor to whom you actually gave a security interest in your property.

Lender Selling the Collateral
After the lender sells the collateral, depending upon your loan agreement, he or she will then apply the money from the sale, less expenses, to your loan. This does not necessarily mean that you are no longer liable to your lender. The loan document you signed may also give the lender the right to get a deficiency judgment against you if the amount realized from the sale is not enough to pay the balance due on the loan. (Deficiency judgments are discussed in other chapters in this book.)

Right of Set-Off
If you have several accounts at one bank as well as a loan, and you fail to make your payments on the loan, the lender may have the right to take the money from your deposit accounts and apply it to your debt. This is called the bank’s right of set-off.

However, the bank may do this only if this was disclosed to you in the loan documents. The bank cannot use your other accounts as collateral without meeting the disclosure requirement. Otherwise, you can sue the bank for damages, including any cost to you for overdrawn checks.

Unsecured Debt
An unsecured loan is one for which the lender has taken no collateral. Most credit cards and any loan given to you requiring only your signature are unsecured loans. (The signature of someone guaranteeing payment, or a co-signer, is given as security for the debt.) Unsecured debt also includes any amount you owe for services, such as doctor’s bills. The service provider (i.e. hospital, doctor, dentist, accountant) and the creditor of an unsecured debt will often first try to contact you personally in an attempt to work out payment of the outstanding bill.

Debt After a Divorce
Anyone who is contemplating separation or divorce should keep in mind that an agreement between you and your spouse is effective only between the two of you. Unless a creditor agrees in writing to release one or the other, both parties remain fully responsible for payment.

Contingent Liabilities
If you have a contingent liability, you will be liable for payment to a creditor only in the event the primary borrower does not pay.

Business Debt
If you own your business and the business is having financial difficulties, these difficulties may affect your personal financial situation as well.

Proprietorship or Partnership
As a new business, you may have entered into leases for space and other legal contracts. If operating as a sole proprietorship, you will be held personally responsible for any contract or agreement you enter into. Likewise, signing as a partner does not protect you from personal liability; all partners are usually responsible for partnership debt.

Corporation
You may have set up your business as a corporation, which is considered a separate, legal entity. Although a corporation usually shields its stockholders/owners from liability, you may still have personal liability as an officer or director.

In other words, if the corporation goes out of business before it has met its obligation under a particular contract, (for example, if the corporation vacates leased space before the end of the lease term) then you may be held personally liable for the remaining obligation.

As a defense against any action against you personally for your corporation’s obligation, you will need to show that only the corporation signed the contract and that you signed as president (or other officer) of the corporation and not individually.

If you have signed a personal guarantee for any corporate obligation, determine whether it was for a secured debt. In other words, is the creditor able to take the collateral as payment for the balance owed? (Your guarantee may be conditional, requiring the creditor to first take the collateral, or unconditional, allowing the creditor to come directly to you for payment regardless of the collateral.)

While your guarantee of payment might not require the creditor to first take the collateral in satisfaction of the debt, the creditor may be willing to do so to minimize any potential losses, particularly if the creditor believes that you personally may not be able to pay the amount due.

Personal Guarantee
As for business leases that you have personally guaranteed, the landlord may be obligated to minimize its losses by finding another tenant as quickly as possible. (State laws vary on this issue.) However, any landlord attempting to obtain a judgment against you, personally, for the balance due on a lease may find the court much more receptive if he or she can show that he or she made a diligent effort to re-lease the space. You should do your best to help the landlord in finding a new tenant to minimize your liability under the guarantee. Even if the law does not require the landlord to attempt to minimize damages, your efforts may discourage the landlord from proceeding against you for the full amount due on the lease.

If there is any question as to whether the guarantee is legally valid and enforceable by the landlord, you should discuss this with an attorney.

Joint Liability
If you have signed a document for payment of an obligation containing the words joint and several liability, along with other owners of your business, do not assume that you will be responsible for repayment only to the extent of your share in the business. Joint and several liability means that each of t

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Credit Smart

Gudrun Maria Nickel, Attorney at Law

Written in easy-to-understand language, Credit Smart takes you from learning about credit history and the credit application process to using credit responsibly.

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