Why You Should NOT Sign A Reaffirmation Agreement On Your Home Loan

In Chapter 7 bankruptcy cases, clients with secured loans (such as their car or home loan) must decide whether to “reaffirm” the debt on the loan.  After the Chapter 7 bankruptcy is finished, a signed reaffirmation agreement allows the creditor to treat the loan as if the bankruptcy had never occurred.  In order to keep some types of property, a reaffirmation agreeement is required.  For example, if a client fails to sign a reaffirmation agreement on a car, then the creditor can repossess the car after the bankruptcy is over, even if the client is current on their payments.

However, a reaffirmation agreement is not required to be signed on a home loan or mortgage.  Clients are often interested in signing a reaffirmation agreement on their home, figuring that they never intend to default on the loan, and that the reaffirmation agreement will be helpful in reestablishing their credit.

Many mortgage companies will stop reporting the status of payments to credit bureaus after a Chapter 7 discharge.  The reason they stop reporting to credit bureaus is because there is a chance thatIf they continue reporting the payment history, then it will be considered an attempt to collect a discharged debt. This could subject them to a violation of the discharge order with the bankruptcy court and could be construed as a violation of the Fair Credit Reporting Act.  For these reasons, the payment history on a mortgage may not show up on credit reports after Chapter 7.  In these situations, I recommend clients get a payment history from the mortgage company (or their own bank), and submit their own payment history to the credit bureaus.  Once the credit bureaus receive the payment history, the mortgage company must either dispute the records within thirty days, or acknowledge that the client’s records are accurate.  This process should be done every year after the bankruptcy.

In most cases, the risk of defaulting on the loan in the future is greater than the possible benefit to the client’s credit score.  After bankruptcy, clients sometimes lose their job, become disabled, or get divorced, which has the effect of making the mortgage payment unaffordable.  In those situations, if the client is unable to sell the home,  then the mortgage company will foreclose on the property.  If the property sells at a foreclosure sale for less than the balance owed on the mortgage, then the client could be sued for the remaining balance.

However, if the clientdid NOT reaffirm the debt, then the client could walk away from the home without worrying about the possibility of a foreclosure.  The mortgage company simply could not pursue the client for a deficiency, since there was no reaffirmation agreement.

I recently received a call from a former client facing this exact situation. The clients have moved from Arkansas, and can’t afford to continue making payments on the home.  They have been unable to keep the home rented, and wanted to know their options.  I was able to advise them that they did not have any further liability on the loan, and could surrender the property or allow the mortgage company to foreclose without worrying about a possible deficiency claim.  If they had signed a reaffirmation agreement, then their options would have been much more limited.

If you have questions about reaffirmation agreements or rebuilding your credit after bankruptcy, please call.  Chapter 7 bankruptcy is a beneficial tool to help a person get back their financial freedom, as long as they don’t handcuff themselves to an unwise reaffirmation agreement.

Reaffirmation Agreements in Chapter 7

Reaffirmation Agreements

A reaffirmation agreement is a written promise to be responsible for a debt after bankruptcy. In 2005, the bankruptcy code was changed to require debtors to sign reaffirmation agreements to keep automobiles and other property pledged as collateral for a loan. If a reaffirmation agreement is not signed, a creditor can repossess an automobile after bankruptcy (even if payments are current). However, the creditor can’t collect any deficiency claim if the collateral is sold for less than the amount of debt. If a reaffirmation agreement IS signed, the creditor can’t repossess an automobile UNLESS the borrower defaults.

Before 2005, debtors could retain collateral (such as automobiles, mobile homes, boats and real estate) in the absence of a signed reaffirmation agreement, as long as payments were kept current.  Until recently, the law was not clear whether a creditor could require a reaffirmation agreement on real property used as the debtor’s residence.  According to In re Covel, 474 B.R. 702 (Bankr. W.D. Ark. 2012)., a reaffirmation agreement is not required as a condition of retaining real property used as a residence.

Why wouldn’t someone reaffirm a debt?

If there is no reaffirmation agreement, a debtor can surrender collateral without worrying about a deficiency claim from their creditors. In most cases, debtors fully intend to pay their monthly mortgage until they sell the home or pay it off.  In some cases, a debtor falls victim to a disability, job loss, divorce, or other situation where they can’t afford their mortgage payment. In these cases, a debtor can walk away from the debt without fear of a lawsuit or collection claim if a lender forecloses on the property.

Housing Crisis and Foreclosure

With the housing crisis that started in 2008, many debtors found out that the debt owed on their home exceeded the value. Instead of a “short sale”, debtors who have not signed a reaffirmation agreement can surrender a house without worrying about a possible deficiency judgment.

Private Mortgage Insurance (PMI)

As a practical matter, most debtors have private mortgage insurance until the debt owed falls below 80% of the fair market value of the property. However, without private mortgage insurance, a debtor risks a chance that a foreclosure sale might not pay off the outstanding debt.  In Covel, the debtor was concerned that if her home ever went into foreclosure due to a job loss, she would have remained personally liable for any deficiency after a foreclosure sale. Interestingly, the debtor had always taken good care of her property, had an excellent relationship with the bank, and had never been late on a her mortgage payments. The court noted that although Congress changed the law requiring debtors to reaffirm debts secured by personal property, nothing in 11 U.S.C. § 521(a)(2) required reaffirmation of the loan on the debtor’s home.

Debt Settlement Advice

Debt settlement companies and debt negotiation companies frequently promise more than they can deliver. They typically offer to settle your debts for a fraction of the balance. However, settlement of multiple large debts can be difficult to achieve, especially if one or more creditors decides to file suit. When clients get sued and face the possibility of garnishment, they discover that bankruptcy may be the best option.

Even if a debtor is successful in settling several debts, they sometimes don’t realize that the “forgiven debt” might be reported to the IRS as income on Form 1099-C. If you fail to report the income on your tax return, the IRS could send you a bill for the taxes owed.

One way to avoid the possibility of receiving an IRS Form 1099-C is to file for bankruptcy protection. Debt that is discharged in bankruptcy is not considered income, and will not trigger a new tax liability. If you are insolvent at the time a IRS Form 1099-C is filed, you should contact an attorney or tax adviser to see if there is a way to avoid the tax liability arising from forgiven debt.

Unfortunately, many debt settlement companies can’t deliver the promised results. In my practice, I have represented several individuals who contacted me after they unsuccessfully tried to get out of debt by using a debt settlement company. Most clients quickly learn that bankruptcy can provide affordable, fast relief, with much more predictable results. If you are not sure if bankruptcy is right for you, be sure to contact an attorney for an assessment of your legal options.

Keep Your Car After Bankruptcy

Stop Repossession

Keeping your car after bankruptcy is possible with Chapter 7 or Chapter 13 bankruptcy.  Chapter 13 bankruptcy may allow you to stop repossession by forcing the creditor to change the loan payment terms. In addition, if you bought your car more than 910 days before filing Chapter 13, you may be able to force the lender to accept less than the balance owed on the car. When the loan is more than 910 days old, the creditor must accept a payoff equal to the fair market value of the car. This procedure is called “cramming down” the loan.  If you purchased your car less than 910 days before filing Chapter 13 bankruptcy, you won’t be able to “cram down” the loan. However, in all Chapter 13 bankruptcy cases you will get five years to pay off your vehicle, at a reduced interest rate.

Reaffirmation Agreement

Chapter 7 cases do not allow you to “cram down” an automobile loan. Instead, you will be required to sign a reaffirmation agreement on the debt in order to keep the vehicle. Reaffirmation agreements require you to keep paying the regularly monthly payments on the vehicle under the terms of the original contract. When you reaffirm a debt, you will be responsible for the debt after receiving a Chapter 7 bankruptcy discharge. Be careful about reaffirming a debt. If the vehicle is repossessed after your bankruptcy, you might be liable for a deficiency claim if you signed a reaffirmation agreement.

Bankruptcy Protection for Retirement Accounts

The U.S. Bankruptcy Code gives generous bankruptcy protection for retirement accounts. In most cases, the bankruptcy code allows you to protect your retirement plans from the claims of creditors. Most 401k plans, IRAs, pension plans, defined benefit plans, or other forms of retirement accounts are protected from creditors when you file for Chapter 7 or Chapter 13 bankruptcy. Some clients make the mistake of depleting retirement accounts to try to keep making minimum payments on credit cards, medical debts, or other debts.  Unfortunately, many clients wind up filing for bankruptcy protection after they have already lost all of their retirement.

Before depleting your retirement account to pay creditors, contact an attorney to find out your options. Most clients are not required to give up any property when they file bankruptcy. This is particularly true in the case of retirement accounts. Although there are some restrictions on the timing of contributions to an IRA or other retirement account, bankruptcy protection for retirement accounts allows you to keep what may be your largest asset after bankruptcy.

Be sure to talk to an experienced attorney about bankruptcy protection for retirement accounts if you are in financial distress. Many financial problems get worse if they are not addressed with a reasonable plan, which should include an evaluation by an attorney. We offer free consultations in most cases, and will help you map out the best course of action.

Top 5 Benefits of Bankruptcy

  1. Stop Debt Collectors and Lawsuits With an Automatic Stay: One of the top benefits of bankruptcy is the automatic stay, which stops all collection activity in its tracks. An “automatic stay” is a bankruptcy court order that prohibits creditor phone calls, demand letters, repossession, lawsuits, foreclosure, or garnishment. This court order also prohibits the threat of any collection activity. In most cases, the only way a creditor can lift the automatic stay is with permission from the bankruptcy judge. The automatic stay goes into effect the minute your case is filed, and is a powerful tool that protects you during your bankruptcy case.
  2. Keep Your Property Using Exemptions: Many clients are surprised that the bankruptcy code doesn’t require debtors to give up all of their property.  In fact, most clients keep all of their property after filing bankruptcy Under Chapter 7 and Chapter 13. The bankruptcy code says that you are entitled to claim as exempt several categories of property, within certain dollar limits. Exemptions are categories of property that the law says you can keep after the bankruptcy case is finished.  For example, a single person is entitled to a homestead exemption in the amount of $22,975.00 on their home or other personal property used as a residence.  A couple is allowed to double the exemption amount and retain $45,950.00 worth of equity in their home or personal property used as a residence. Other exemptions exist to protect household goods and furnishings, vehicles, jewelry, tools of the trade, clothing, life insurance, and other items. An experienced bankruptcy attorney can help you keep the maximum amount of your property allowed by law. In addition, retirement accounts enjoy special protections under the bankruptcy code.  Before you decide to liquidate your retirement to pay creditors, see if a bankruptcy lawyer can protect the account by filing bankruptcy. In most cases, an IRA, 401k, pension plan, or other retirement account will be protected if you file bankruptcy.
  3. Stop Foreclosure and Repossession: Filing bankruptcy may help you stop a foreclosure or repossession. Under Chapter 13 bankruptcy, your attorney will help you prepare a plan of reorganization to “catch up” missed payments over time, typically three to five years. For example, suppose you are behind on your mortgage by six months, and the monthly payment is $1,000.00 per month.  The total amount of past due payments under this scenario would be $6,000.00, which might be impossible for you to catch up before a foreclosure sale of your property. Under Chapter 13 bankruptcy, you can propose a plan of reorganization that pays off the $6,000.00 in missed payments over a five-year period.  In that situation, the mortgage could be brought current with payment of the regular mortgage amount plus an additional $100.00 per month.  (60 months x $100.00 = $6,000.00.)  In this example, stretching out the repayment of the past due balance over time would allow you to keep your home with a manageable repayment plan. After the bankruptcy case is over, you would resume regular payments to your mortgage company. Finally, assuming you qualify for Chapter 13 bankruptcy and make all of your plan payments, you will be able to emerge from bankruptcy with a discharge of your remaining unsecured debts. A discharge order permanently extinguishes the remaining indebtedness owed to most unsecured creditors after your bankruptcy case. To qualify for Chapter 13 bankruptcy, you must have a source of regular income and be willing to commit a portion of your monthly income to a Chapter 13 plan of reorganization. An experienced bankruptcy attorney can help you decide whether Chapter 13 bankruptcy will help you in your particular situation.
  4. Business Owners and High-Income Earners Are Often Eligible for Chapter 7 or 13: High income earners can benefit from filing bankruptcy. Sometimes clients don’t call a bankruptcy lawyer because they think they make too much money or will have to give up everything they own. Despite the changes in the law in 2005, many people with high income are still eligible for Chapter 7. The Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 (BAPCPA), required most people to fill out a complicated “means test” form. On the means test, your household income for the six months preceding filing is compared to the average income of the same household size in the county where you live. If your household’s gross average income in the six months before filing bankruptcy is less than the average monthly gross income for a household of a similar size in the county where you live, then you will be eligible for Chapter 7. If your household gross income exceeds the median household income for a family of a similar size, then the “means test” allows deductions from gross income such as taxes, secured payments on debts that will be due over the next sixty months, and other living expenses. After subtracting all of the allowable deductions from the six month gross average income, your attorney will be able to determine whether sufficient funds are left over to pay some portion of your unsecured debts. If a debtor passes the means test, Chapter 7 bankruptcy is available. If the debtor does not pass the means test, the debtor may still be eligible for Chapter 13 bankruptcy. High income earners may still be eligible for Chapter 7 bankruptcy even if they would “fail” the means test. For example, if a person’s debts are primarily “non-consumer” debts, then the person is not required to pass the means test and will qualify for Chapter 7. Consumer debts are debts incurred primarily for household purposes. If more than 50% of a person’s debt is non-consumer debt, such as business loans, business related credit card debt, or other trade debt, then the person is not required to pass the means test in order to be eligible for Chapter 7 bankruptcy. This statutory provision can be very helpful to people who have business loans or personal guaranties, and are seeking a fresh start. An experienced attorney can help you decide if Chapter 7 bankruptcy might still be an option, even if you are a high income earner.
  5. Bankruptcy is Quicker and Less Expensive than Debt Settlement: Debt settlement companies often make a bad situation worse.  Over the years, I have met with many clients who have told me that they tried to settle their debts using a debt settlement firm or debt negotiation company. These companies advise the client to stop paying their credit cards, stop accepting phone calls from creditors, and to refer all such calls to the debt settlement company. In addition, these companies often require monthly automatic bank drafts from the person’s checking account to pay debt settlement fees and to build up a reserve account. The reserve account is supposed to be used by the company to try to settle each of the client’s debts in a lump sum payment. This process is often accompanied by a promise that the debt settlement company will be able negotiate a settlement whereby the creditor will likely accept pennies on the dollar to settle the debts. This strategy of stopping payments on credit cards and referring calls to a debt settlement company has serious detrimental consequences. First, stopping all credit card payments causes the client’s FICO credit score to plummet. The debt settlement companies know this, and use the damage to a person’s credit as a tool to help them negotiate with credit card companies. Meanwhile, the credit card companies tack on late fees, put the account in default, and raise the interest rate to the default rate. This process causes a sharp increase in the balances owed on credit cards. In my experience, the debt settlement companies don’t deliver the promised results. Nothing in the debt settlement process stops a credit card company from filing a lawsuit. Unfortunately, by the time a client has contacted my office, they have already paid $4,000.00 to $5,000.00 to the debt settlement company. In addition, very few of the debts have been successfully settled, and the client is facing a lawsuit or garnishment. In most cases, the client could have contacted an attorney to see if the attorney could help them settle their debts, or determine if bankruptcy would be a better option.  In some cases, the development of a strict family budget and help from an attorney negotiating on their behalf can keep a client from being forced into bankruptcy.