Debtor and Creditor

Creditors' Legal Rights

By Amy Loftsgordon, Attorney
Learn how creditors can collect secured and unsecured debts when debtors don't pay.

“Creditors’ rights” are the legal tools available to creditors when their debtors fail to repay a financial obligation (known as “defaulting” on a debt). How the creditor can recoup its money depends on whether the debt is secured or unsecured.

Secured and Unsecured Debts

Debts generally fall into one of two categories: secured or unsecured. If a debt is secured, this means that the debtor has pledged property—known as collateral—as a condition to getting the loan. Collateral can be either the item the debtor borrowed money to purchase, or something else of value that the debtor already owns. When someone borrows money to buy a car, for example, the car is collateral for the loan. In the case of a home loan, real estate is the collateral. Inventory or equipment can also be used as collateral to secure a loan.

If a debtor doesn’t repay a secured loan, the creditor can take specific steps as outlined in both state law and the loan contract to take the collateral away from the debtor and keep it (or, more likely, sell it to satisfy the debt).

With an “unsecured” debt, the debtor has not pledged collateral that would be available to the creditor if the debtor defaults. Credit card debt is an example of unsecured debt. If the debtor fails to pay unsecured debt, the creditor cannot take property from the debtor to pay off the amount owed—at least not right away (see “How a Creditor Collects Unsecured Debt,” below).

How a Creditor Collects Secured Debt

Once a secured loan goes into default, the creditor generally has the right to take the collateral by repossessing it or foreclosing.

Repossessing Collateral

When a debtor stops making payments on certain secured loans, like a car loan, the creditor can repossess the collateral. The creditor does not have to go to court to get permission to take the collateral, because the terms of the original contract state that the creditor may reclaim the item if the debtor defaults.

Although the creditor has the right to take (repossess) the debtor’s property, the creditor (or its agent) cannot “breach the peace.” This means the creditor can’t use or threaten to use physical force against the debtor to get the item back. In most states, a creditor will avoid breaching the peace as long as the creditor avoids a confrontation during the repossession. If the peace is breached (for example, by pushing the debtor out of the way and breaking into a locked garage to get the item) the debtor can sue the creditor.

After repossessing an item—a car, for example—the creditor can sell it. Sale procedures and notice requirements about the sale are set by state law. The creditor uses the money received from the sale to repay the debt. If the car sells for less than the amount the debtor owes, the creditor can sue the debtor to get a deficiency judgment. (The “deficiency” is the difference between what the debtor owes and what the creditor receives from selling the car.)

Foreclosing

As part of a home loan transaction, the lender often requires the debtor to sign a mortgage or deed of trust. This document gives the creditor the right to sell the home—the collateral—through a process called foreclosure if the debtor does not make the loan payments. The lender uses the proceeds from the sale to pay off the home loan.

The foreclosure process is more complicated than repossession. In around half of the states, the creditor must file a lawsuit in court to foreclose. This is called a judicial foreclosure. Judicial foreclosures normally take at least several months, and as long as a few years in some states, to complete.

In the remaining states, the creditor can use an out-of-court process to foreclose. This is called a nonjudicial foreclosure. The creditor must carefully follow a series of steps described in the state statutes to complete the process.

A nonjudicial foreclosure commonly involves:

  • sending the debtors a notice of default informing them that they are behind in payments
  • recording the notice in the county records
  • providing a notice of sale, and
  • publishing information about the sale in a newspaper.

Nonjudicial foreclosures are generally much shorter than judicial ones, taking just a few months or less to complete in most cases.

How a Creditor Collects Unsecured Debt

Collecting on an unsecured debt is typically more difficult than getting paid for a secured debt, because the debtor as not pledged any collateral that the creditor can seize and sell. But this doesn’t mean that the creditor is out of luck.

The creditor may refer the unpaid debt to a collection agency whose job it is to collect the money owed. If the debtor incurred the debt for personal, family, or household purposes, the collection agency must comply with the Fair Debt Collection Practices Act (FDCPA). The FDCPA includes various disclosure requirements and prohibitions on harassment of debtors. If the collection agency violates this law, it could be liable to pay damages (money) to the debtor.

If the debtor still refuses to pay the unsecured debt, the creditor can file a lawsuit against the debtor. Once a court grants judgment in favor of the creditor, it can usually take money from the debtor’s bank account or garnish the debtor’s wages. Also, an unsecured debt can become secured in cases where the creditor files a judgment lien on the debtor’s property after winning a lawsuit in court.

Getting Help

A creditor’s rights attorney helps creditors collect money owed and settle disputes between creditors and debtors. If you are owed money and need further information about how to recover it, consider contacting a creditor’s rights attorney.

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