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How does bankruptcy impact encumbered assets?

A feeling of humiliation and fear of a poor credit rating often keep Americans, including those in Wisconsin, from filing for bankruptcy, even though most people end up far better off financially. Some of this resistance to filing for personal bankruptcy comes from a lack of information or ideas that turn out to be untrue. One of the most commonly misunderstood topics is encumbered assets.

What is an encumbered asset? Anytime a potential borrower lists an item as collateral when taking out a loan, that item becomes encumbered or tied up and unavailable for disposal by its owner until the loan has been paid off. For instance, when a homeowner secures a second mortgage loan to make home improvements, he or she typically puts up the house as collateral and the loaning party thus has a financial stake in that property until the second mortgage loan is paid off.

What happens if a loan is not paid off according to its contract terms? In these cases, a creditor can take action against a debtor. Some creditors obtain liens against a debtor's assets either because they have won a lawsuit against the debtor. The law also provides the possibility for an automatic lien for certain claims such as taxes or purchases that have not yet been paid off.

What are oversecured and undersecured loans? If the collateral assets are worth more than the secured debt, the loan is considered oversecured and the creditor is only entitled to the original amount loaned. When loans are undersecured, creditors can file additional claims to equal the total original amount loaned to the debtor. This is usually seen when a debtor files for bankruptcy.

In most cases, a debtor is better off consulting a legal professional who understands the complications and can find a solution that benefits the bankruptcy filer.

Source: American Bar Association, "Consumer Bankruptcy," Accessed on June 10, 2015

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