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.