Are you working your way to pay off a liquidated debt or an unliquidated debt? What’s the factual difference between both terminologies? Moreover, does “liquidated debt” carry the same meaning as “liquidating one’s debts?”
You can give this article a read to untangle all your questions related to liquidated debt. By staying informed, you can have a better understanding of your personal and business-related finances. In turn, you will manage to move on with your financial proceedings while considering all your options wisely!
Let’s start with the very basics and understand what liquidated debts are in the simplest of words.
What are liquidated debts?
Incurring debts and paying them off is part of running any business. After all, most newly formed organizations have to ask for capital and debts from creditors to kickstart their business. There’s no way to avoid accumulating liabilities when you don’t have your own money to fund a business. However, despite what people assume, “debt” is not an off-putting factor as long as you’ve set up a proper timeline to make the repayments, and you also ensure to stay well under the timeframe.
However, having said that, some debts can become somewhat of a nuisance when there’s a prominent question mark on the amount that is needed to be paid off.
Under any circumstances, a “liquidated debt” is the best kind of liability to have for businesses since there are no ifs and buts about the debt amount. Here’s the proper definition for this terminology to put things into further context:
“A liquidated debt is one where both parties, the creditor and the debtor, have a clear understanding regarding how much money is owed.”
In other words, any debt in which the due amount is clearly stated is referred to as a liquidated debt. In most cases, this due amount is clearly stated from the beginning since it isn’t all that challenging to figure out the exact debt in certain situations.
Not to mention, the creditors can also make the process easier for the borrower by sending them a statement. This financial document is usually sent monthly, and it includes the debtor’s outstanding charges, interests that have been accrued over time (if any), and the overall debt balance with the established billing cycle. For example, an auto loan or a mortgage can be excellent examples of liquidated debts in such a case.
Other times, the involved debtor may have to work with the creditor, or even the court or an attorney, to establish an agreed-upon amount. Of course, in this case, the due amount is not too obvious. This is primarily true when there’s a disputed or contingent debt on your name.
- A disputed debt occurs when there’s a certain clause in the contract or agreement initially drawn between both parties, which is stated unclearly. For example, the borrower may deny any responsibility of paying off their debt, to begin with. Or, the debtor may dispute the balance when there’s no acknowledgment of crediting any payments in the document that have already been made to the creditor. Furthermore, debt disputes may also arise when the borrower files for bankruptcy and the creditor submits wholly different debt claims to the trustee, compared to what was initially provided by the debtor.
- On the other hand, a contingent debt is an unusual type of liability because it is primarily dependent upon uncertain future occurrences or developments. Simply put, it’s an indefinite liability solely based on a future event’s outcome. For example, think of a due amount that needs to be settled between both parties by means of a court verdict. These obligations aren’t recognized in the financial statements as well until the final decision is made about the due amount.
In the mentioned two cases, the borrower (or their bankruptcy trustee) strives to seek solid proof of the claims made by the creditor. This is the only way to resolve the disputes and re-liquidate the debts like before. Ultimately, once there’s a fixed amount clearly stated and acknowledged where both parties see eye to eye, it has to go down on a legal contract to seal the deal. If that’s not the case, it is mandatory to carry at least some legal proceeding to put a stamp on the undisputed outstanding amount.
What are unliquidated debts?
No matter how meticulously you manage your company’s bookkeeping, sometimes, you can’t help accumulating debts that neither you nor the creditor is sure about in terms of money. The exact amount to be repaid is unknown, and therefore, there is no structured or fixed timeline to make repayments. These debts have to go under dispute so that the court can sort out the situation for the payer and the payee. This is commonly referred to as “unliquidated debts” in accounting.
As mentioned in the previous section when discussing the liquidated debts, “disputed debt” and “contingent debt” are the best examples of such a case. Businesses facing unliquidated debts have to remain responsible for it until the matter is resolved in a legal way. Once the court figures things out and establishes the correct due amount, the liability again turns into a liquidated debt for the borrower. From there, the creditor and debtor can agree upon a certain timeline to make repayment arrangements.
Ultimately, it is crucial to turn all your unliquidated debts to a liquidated state, even when you need to file for a bankruptcy case so you can’t leave them “as is.” That’s because unless your debt values aren’t specific, your bankruptcy trustee wouldn’t agree to pay a claim. Similarly, it’s imperative not to have any pending contingency or disputed debts before filing for bankruptcy due to the same reasons.
Examples of liquidated debts vs. Unliquidated debts
Debts can arise from various sources. Here are two examples that will explain to you how liquidated and unliquidated debts differ from each other in distinct circumstances:
#1) Let’s start with one of the simplest and common situations most of us encounter or at least witness in our daily lives – that is, torts. Tort law is related to civil wrongdoings where an individual causes damage to another person or their property. Here’s a real-life scenario for further clarification:
Suppose you were driving during the rush hour and accidentally rear-end the car idling in front of you. The driver ahead hit their head on the steering wheel and had to be taken to the hospital immediately for a check-up. After their treatment, medications, and car maintenance, the driver had to pay $5,000 for everything in total. Since the amount is bound to be accurate due to the available hospital slips and car repair shop bill, there would be no apparent reason to dispute that amount from either side. In short, you will know the exact amount of money you owe to the driver, which automatically categorizes your liability as “liquidated debt.”
However, let’s say when you hit the car in front of you, the driver ended up requiring an extended treatment instead of sustaining minor injuries. In this case, it could take an indefinite amount of time for them to recover, including multiple doctor appointments or undergoing a few surgeries. Until the injured driver is fully recovered, the total debt amount will remain unknown. Therefore, it will be categorized as “unliquidated debt” until both parties know precisely how much it took to deal with the medical and car maintenance expenses.
There are two ways to handle the unliquidated debt in this scenario. The first option is to come to an agreement with the driver and settle how much money you should pay them to get off the hook permanently. If the driver agrees to a certain amount, releasing you from any type of future responsibility, the debt is considered “liquidated” again.
On the other hand, let’s say you dispute how much money you owe to the driver or whether you are even liable for the car accident to begin with. In that case, the injured driver has the right to take you to court. From there, the judge takes on the responsibility to conclude the proceeding.
If the court admonishes that you aren’t responsible for the accident, you can be free of all liabilities. However, if it’s the other way around, it could be ruled that you owe the driver, say $10,000, to compensate for their expenses. Again, since the court has established a specific amount and now you know exactly what to pay, the debt is considered “liquidated.”
#2) The liquidated and unliquidated debts can also take on contractual form and aren’t limited to accidental circumstances. For instance, let’s suppose you had to take out a loan to buy a personal car. As per the contract terms, you have to pay $400 every month for the next thirty-six consecutive months to pay off the loan, establishing a total of $14,400. The due amount is clearly stated, making it “liquidated” from the get-go. Moreover, even if you decide to make early payments, the debt will still remain liquidated.
For example, let’s say that after a year of delivering a total of $4,800 payment, you unexpectedly come into a little money and decide to pay off your outstanding debt using that. The remaining $9,600 is still a fixed amount since the only difference is that instead of making monthly payments, you’ve decided to eliminate your debt in one go. Therefore, making early repayments doesn’t alter your liquidated debt into any other state.
However, let’s say that instead of coming into money a year after making consistent monthly repayments, you ended up losing your job. With no other significant source of income, you can’t manage any further payments for an indefinite time, which piles up your debt. In this case, it’s quite likely your lender will repossess your car and put it up for sale to make up for their loss. Nevertheless, there’s no way of knowing whether the amount they will get from the sale would be enough to cover your outstanding debt or not (which will be $9,600 after a year of consistent monthly payments). Therefore, until the car is sold, it’ll be registered as an “unliquidated debt.”
There are a couple of scenarios that you can anticipate after that. In the first case, your lender gets the whole outstanding debt amount ($9,600) after making the sale, which leaves you off the hook, settling your debt once and for all. On the other hand, the car is sold at less than $9,600, say $9,000, so now you owe a fixed amount of the remaining $600 to settle your debt.
The due amount was unknown until the time the sale was made, making it unliquidated debt. However, now that you know what you owe to your lender after the sale, you’re again responsible to pay for the fixed “liquidated debt” of $600.
Is “liquidated debt” similar to “debt liquidating?”
Even though we have discussed liquidated and unliquidated debt in detail by now, several people still confuse the concept of liquidated debt with debt liquidation. After all, both terminologies hold the same words, so they are bound to have some things in common, right?
Although our logic compels us to say “yes” to this question, we must understand that both these terms carry different meanings. In point of fact, liquidated debt is something we relate to in the field of accounting where the borrower owes a specific amount of money to the creditor.
On the other hand, debt liquidation means “paying off your debts, taxes, and all other company / personal liabilities by selling the business or private assets you own.”
If you have a ton of loan and credit card payments on your name, and it is leaving you scrambling for money, debt liquidation is the only way out most of the time. When you sell all your company assets, this eliminates the accumulating debts even if there’s no business to speak of afterward. You can choose to walk this path on your own choice, or bankruptcy will force you to liquidate your debts. Either way, the primary purpose of debt liquidation is to satisfy your creditors when you have pushed past the repayment deadline, and there’s no hope for your business’s future growth as well.
That said, it’s crucial to understand that you aren’t left with a dime yourself at the end most of the time when the accumulated debt is too much. Therefore, it’s essential to evaluate all your options beforehand when converting your stocks, real estate property, or other valued items into cash.
Considering what debt liquidation entails, it’s crucial to set up a system and analyze your financial state accordingly before making any final calls. If you’re wondering how to liquidate your debts, you can refer to the following section to enhance your chances of posing as little risk to your financial standing as possible.
Determine the amount of debt you can handle monthly
It’s vital to observe that liquidated debts can also be paid off without having to cut your business from the cord, even when all your liabilities are related to your company. Similarly, you don’t have to liquidate your house if that’s the only way of keeping a roof on your head. However, to establish how you can achieve that, you first have to evaluate the amount of money you can manage to pay off monthly. That’s because you don’t necessarily have to eliminate your debts from the root to reach a financially sound ground. Instead, you only have to lessen the debt such that you can pay the remaining amount without scrambling to get by.
Once you’ve established how much debt you can take on without encountering any problem while also taking unexpected monthly expenses into account, your first step should be to contact your lender. You can strike a deal or negotiate with them to restructure a suitable repayment schedule, distributing the amount over an extended period. This, in turn, frees up some cash for you while allowing you the opportunity to focus on other necessary expenses as well.
On the other hand, if you can’t go with plan A due to any reason whatsoever, your second option could be to liquidate some of your assets to eliminate a portion of your due amount. The assets you liquidate to pay for a part of your debt should free up enough of your expenses to make a monthly repayment schedule that you can match adequately. For example, if you’re running a business with five different departments, you can consider liquidating one of them to allow yourself some wiggle room. This will help you run other departments more adequately.
Ultimately, this is one of the best ways to make arrangements for your liquidated debts without having to liquidate your debts.
Considerations to make
Suppose you’re looking to liquidate some assets to pay off a section of your liabilities. When that’s the case, your first instinct might be to consider liquidating only those assets first that aren’t absolutely necessary for you. For example, you can make plans to liquidate your financial investments, IRA accounts, or 401k funds. However, when doing that, you should take into account that there might be some short and long-term consequences associated with your activity as well.
For example, taking money out of your retirement account may get you taxed or financially penalized when you make early withdrawals. Moreover, the tax you will have to pay on the extra cash could even move you to a higher tax bracket. Nevertheless, paying off a part of your accumulated debt can still give you a fresh start if you have plenty of years before retirement. Therefore, it’s imperative to weigh the consequences of each step before you make any final call.
Not to mention, it’s always better to focus on your real estate property or other personal belongings with cash value before thinking about taking out money from a savings account. For instance, suppose you own a large property or even a small one in a good area. In that case, you can consider moving elsewhere where real estate isn’t that expensive. Similarly, selling your expensive car to opt for a smaller one can also put you in a better position debt-wise. While it’s always disheartening to relocate or downsize, sometimes that’s the best option you have to settle your debts.
Ultimately, when you have a high liquidated debt to worry about, you need to think long and hard before establishing what to sell and how it might affect your life currently and in the foreseeable future.
Consider your options when filing for bankruptcy
Let’s suppose you have no other way but to sell off your property to settle your debts. However, even the amount you’re promising to get in return is not enough to put you on financially stable ground. Of course, when that’s the case, you will have to assess your situation and consider the possibility regarding what you will do if your financial situation doesn’t improve. The only way out in these circumstances is to file for bankruptcy. It will be your last resort to save yourself from paying a ton of debt that you can’t even begin to contemplate.
Furthermore, depending upon the type of bankruptcy you file for, there’s a good chance you can lay off a significant part of your liquidated debts. However, even then, the court may decide to ask you to surrender a few items of your property. Agreeing upon a dollar amount on the liquidated or undisputed debts is usually to satisfy your creditors so they at least get a part of their money back.
Moreover, having said everything, it’s crucial to understand that filing for bankruptcy is no easy feat and has long-term consequences. For example, it takes a massive toll on your credit score and history, which can limit you financially in the future when you need to loan out money again. Plus, the process itself is a long one where you need to complete several different paperwork, mentioning all your debts in them.
In the documentation, your debts are referred to as “claims” because the creditor always has the choice to claim those funds. In most cases, the claims are straightforward, and no one has any reason or intention of triggering a dispute.
All things considered, it’s best to discuss the route to bankruptcy with an attorney beforehand when you’re considering liquidating your debts in this fashion.
Dealing with small business debts
Lastly, let’s talk about the situation when you’re the owner of a small business and need to liquidate all your business assets to pay your creditor or a group of creditors. When that’s the case, you will have to take everything into account so as not to miss anything afterwards. For example, the assets you may need to liquidate include your business area (real estate property), company equipment, art and supplies, furniture, prepaid insurance, and business-named vehicles.
Furthermore, you might also need to sell off your intangible assets, such as contracts and commercial leases. It’s also better to list down all these assets from A to Z with their description, delineating the financial condition of the properties and personal or business funds.
Once everything is listed out and ready to liquidate, the next most important step is to look for potential buyers, who you can sell your assets to at a good enough price. This will help you eliminate a significant part of your debt, if not the whole amount, that you might have incurred during your business proceedings.
How to deal with liquidated debt using “debt reorganization” methods?
“Debt reorganization” is the method of altering your liabilities in a legal way such that it is made financially easier for an individual or a business to pay off their due amount. There are multiple methods to settle your liquidated debts using different techniques, from debt refinancing and rescheduling to debt restructuring, consolidation, and debt assumption.
In this section, we’ll review the mentioned processes in detail to understand different ways of settling a liquidated debt without encountering a financial fall.
Debt refinancing invokes the image of a struggling company in search of a way to avoid bankruptcy. In the simplest of words, refinancing means “replacing an existing debt with a new one by signing an entirely different contract from what was initially established in previous terms and conditions.”
The debt conditions applied in the new contract are structured after the renegotiation of the previously established repayment deadline, due amount, and interest rate frequencies. The renewed contract is primarily based on what tends to be the most favorable option for the debtor. However, it’s essential to have the creditor’s agreement as well before any deal or contract is finalized.
In other words, debt refinancing is the process of asking for a new loan with better terms and conditions to pay for previously existing obligations. Let’s understand this scenario with a real-life example:
Suppose you have a massive loan on your name, but you’re struggling to make ends meet at the time, let alone making timely monthly repayments. Therefore, to have some financial semblance in your life, you decide to apply for a cheaper loan. By doing this, you can use the proceeds from your new loan to pay off your liabilities accumulating from a pre-existing loan. This is the most basic form of “debt refinancing,” which most of us, unfortunately, experience or witness at some point in life.
Simply put, debt refinancing is replacing one loan with another. Even though a lot of people hesitate to indulge in yet another loan to stabilize their financial status, sometimes, that’s the only option they have to save themselves from bankruptcy. In the end, when you have to pay the debt to your lenders, this debt reorganization method seems like no less than a financial life savior.
Moreover, it’s imperative to understand that there can be multiple reasons to refinance your debt. For example, refinancing can be one of the best options to consider when it is essential to reduce your interest rates on loans, change the loan structure, free up some cash for emergency expenses, or consolidate debts.
Not to mention, debtors with high credit scores can especially benefit from taking on this financial path in the long run. If you’re wondering “how?“ the logic is quite straightforward. When you secure the most favorable terms and conditions on your loans with the lowest possible interest rates, it influences other future lenders to offer you a similar lower yield on the interest payments. This is one of the best things a borrower can ask for in their future financial endeavors.
Therefore, it is safe to conclude that refinancing improves your long-term liability while allowing you the opportunity to keep up with the debt repayments much more adequately.
Debt rescheduling, also referred to as loan rescheduling, is used to alter the pre-agreed timeline for paying the due amount of a liquidated debt. This debt reorganization method is usually favored by businesses and even less-developed countries when they struggle to make the agreed-upon repayments under the given timeline.
Therefore, the main purpose of rescheduling your debt is to allow yourself some wiggle room when making the principal repayments. In simple terms, debt rescheduling means “restructuring your loan repayment timeline to prevent yourself from a financial turmoil that might cause bankruptcy.”
This can be done using two different methods. The first option is to reschedule your outstanding debt such that it is scattered over an extended timeline with an increased number of payments. This way, the amount of money you have to pay each time remains reduced to match your budget. Plus, when there’s less payment to worry about, there are also significantly lower interest charges.
The second option is for those individuals, businesses, or countries that want to pay off their debt quickly instead of extending the timeline. This is usually done when they need to focus upon other expenses afterward and can’t afford to let these debts get in the way. Moreover, the debtor is allowed to ask for a small break before they begin making repayments. That is, sometimes, essential when the short break is utilized to get a certain amount of money together for making loan payments.
Afterwards, the repayment timeline has to be shrunk by distributing the outstanding debt in larger chunks. However, it’s vital to note that when the owed amount is paid off in bigger lumps, there’s also a greater interest rate on them.
Either way, the debtor is allowed the advantage of adjusting their repayment plan without having to default on their loans with debt rescheduling. Moreover, before you choose either one of the methods to pay off your loan, it’s best to understand how the interest charges might reflect upon your total due amount.
For example, suppose you choose to go with the first method, deciding to pay off your debt over an extended period. In that case, the interest charges will undeniably be more than what you would have paid if the timeline wasn’t altered, to begin with. However, since that can’t be prevented because you can’t make timely payments, that’s a risk you have to take.
On the other hand, suppose you choose to go with the second method of paying your debt in a shorter time with greater repayments. In this case, many people think they can avoid the extra interest charges that they would have paid if they had chosen the first method. However, in reality, higher repayments mean higher interest charges as well. Therefore, ultimately, you end up paying more interest charges this way than what you would have paid while going for the longer timeline.
Nevertheless, both options have their merits and limitations, and each individual, company, or country decides what’s best for them while keeping these factors in mind.
In summary, debt rescheduling is the method of extending or shrinking the repayment timeline of existing liquidated debt. So, you either pay a lesser amount over a longer timeline or induce a pause followed by larger repayments over a shorter timeline.
When an organization is on the verge of bankruptcy, the process of debt restructuring can offer it valued support during financially struggling times.
While several people confuse debt restructuring with debt refinancing and rescheduling, it is vital to note that there are prominent differences in the execution of all these methods. Please note that it is crucial for everyone to understand the meaning behind these finance-related terminologies and not solely depend on your attorney or any other legal practitioners.
That’s because even seasoned accountants and finance professionals may sometimes use these words interchangeably, which can often give way to unnecessary hassles. After all, saying one word and using something completely different on the legal documents is a recipe for disaster. On the other hand, when you know what all these accounting terms mean, you can handle your financial matters much more proficiently and independently.
In accounting, debt restructuring means “altering an existing contract’s terms by prolonging the timeline and modifying the interest rate charges and frequencies.”
If you’re wondering how it differentiates from debt refinancing or debt rescheduling, let us give you a clear distinction. In debt refinancing, we discussed a complete “contract replacement” followed by negotiation on all loan terms and conditions. Moreover, in debt rescheduling, the debt is either distributed over more repayments over an extended period with reduced interest rates or within a shorter timeline with an increased interest rate.
On the other hand, in debt restructuring, the contract terms are only “partially revised,” and there’s no need to draw another contract from scratch. While all these methods are set in place to enhance financial stability for individuals or people struggling with businesses, the mentioned key distinctions make a significant difference in execution.
Having discussed the basics of debt restructuring, we can’t deny that this debt reorganization process is one of the best ways to settle your liabilities in trying times. However, that said, it’s still essential to understand that restructuring your debts can also cause you a few genuine setbacks.
For example, when you opt to restructure your debts, changing its contract terms, it also gets mentioned in your credit history. In turn, your credit score somewhat ruins your reputation to potential lenders, making it incredibly challenging to get another loan in the future. Moreover, when you keep defaulting on your loan despite the altered conditions, it sets you on the path to bankruptcy.
Not all lenders continue to make exceptions for the debtors to save them from going bankrupt. Therefore, you end up paying a huge amount of money to an attorney for multiple causes. Not to mention, credit counseling and filing charges are not something one could ignore all that easily. Ultimately, the severe the case is, the more likely it is for you to be paying massive charges and attorney bills.
On average, the general attorney fees for filing bankruptcy lies between $500 and $2,200. The end amount depends upon your case. That’s why before you opt to restructure your liquidated debt, it’s better to make sure you can pay off your liabilities after the contract enhancement.
Debt consolidation is the “act of taking out a new loan to pay down other liabilities, including consumer debts.”
In other words, when you have multiple debts on your name, and you combine them to form a new liability such that it nullifies the pre-existing ones, it is called debt consolidation. Usually, the consolidated debt is based on most favorable terms – i.e., better interest rates and lower monthly repayments.
In most cases, debt consolidation is used to manage your liquidated debts better when you’re already struggling to pay for multiple liabilities. These can also include debit and credit card loans, student loans, or any other type of due amount.
To understand this terminology better, let’s take a real-life example:
Suppose you have three credit cards on your name and owe a total balance of $30,000 at a 21.50% annual rate compounded monthly. When that’s the case, you will have to pay $1,549 each month for the next twenty-four months to bring your debit balance down to zero. That means paying off a total of $7,176 in interest over two years.
However, instead of going down this path, what if you try consolidating all your credit cards together such that you have to pay a lower interest at a 10.20% annual rate compounded monthly? In this case, you will have to pay $1,387 a month for the next twenty-four months. This will lead you to pay a total of only $3,288 in interest over the next two years.
When compared, you can save $3,888 in interest in this given situation if you decide to consolidate your debts instead of paying for three different credits separately.
All things considered, this is one of the most preferred ways to deal with liquidated debts since it can save you a ton of money in the long run, preventing you from unnecessarily spending your hard-earned cash.
Debt assumption is yet another method of dealing with liquidated debt, which includes two simultaneously occurring transactions.
In simple words, debt assumption is “a unique form of debt refinancing, in which the loan contract is established between three parties. These include the creditor, the original borrower, and a new debtor. The last party enters the picture to assume the said debt obligation.”
This type of debt reorganization reduces financial stress for the original debtor so that they could continue to operate their expenses better. As established before, the act of debt assumption is performed in two transactions.
The first transaction is set in place to cut off the original debtor’s obligations to the creditor. On the other hand, the second transaction creates a new debt contract between the same creditor and the new debtor (new assumer).
The legal process is carried out through a debt assumption agreement, which is commonly referenced as debt assignment. This concise document holds the identities of all three parties, the due amount, the debt terms, and a sign from each member involved. It’s essential to have this contract thoroughly read and signed by the new debtor in front of a notary since they are to assume the outstanding liability themselves.
Debt assumption is a part of both personal and corporate-related liquidated transactions. For example, in businesses, assumed debts can take place when a merger or an acquisition is in place. In these cases, the new debtor deducts the liquidated debt value from the agreed-upon sale price before making the finalized payment.
Similarly, mortgage transactions can be considered one of the basic forms of personal debt assumption. Following the same principles used in prior-discussed business debt proceedings, the new debtor cuts off the liquidated debt from the property’s sale price before paying for the land. Generally, the liquidated debt consists of an outstanding mortgage, any type of unpaid real estate tax, and all other extra liabilities.
However, although debt assumption can be a great way to settle your liquidated debts, it’s best to realize that personal or private debt assumption might not factor in any positive points on your credit report. Therefore, if you want to maintain your credit score in the long run, you’d be better off using some other debt reorganization method to manage your personal liabilities.
In this article, we’ve covered everything to know about liquidated debt, including its examples and similar accounting terminologies. Using this post as a reference point, you can stay out of financial troubles and keep yourself adequately informed at all stages!