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Why You Should NOT Sign A Reaffirmation Agreement On Your Home

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.

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.