One of the more common questions I get from clients is whether or not they should reaffirm their debt. My answer in almost every case is absolutely not.
What is a Reaffirmation Agreement?
A reaffirmation agreement is a contract that obligates a person to pay all or a portion of debt that would otherwise have been discharged in bankruptcy. It essentially takes the old loan (wiped out in bankruptcy) and brings it back to life. It is important to note that reaffirmation agreements only apply to secured loans (mortgage, car loan, furniture loan, etc) that have been included in a chapter 7 bankruptcy.
Reaffirmation agreements are voluntary and are not required by the Bankruptcy Court. In fact, every reaffirmation agreement needs to be approved by your attorney (if represented) and the Judge assigned to the case. An attorney must certify that the agreement does not impose an undue hardship and a Judge must agree that it is in the Debtor’s best interest.
Lenders may tell you that you are required to reaffirm the debt, however, this is not true in Massachusetts. Laws differ from state to state, but in Massachusetts there is a law that prohibits a lender from repossessing a car or foreclosing on a home if one is current on the loan and insurance.
If reaffirmation agreements are voluntary, why would I sign one? Doesn’t this take away from the fresh start the bankruptcy provides?
Detriments of Filing a Reaffirmation Agreement
When you file a Chapter 7 bankruptcy case, you are eliminating your personal liability to your secured creditors. The lien on the property remains and you need to keep making your monthly mortgage or automobile payments if you wish to retain the items. If you are unable to continue making the payments due to loss of job, medical issues, or any experience that makes it difficult to make your monthly payments, you can stop making payments and let the lender foreclose or repossess the property. If the home or automobile is sold at auction and the lender receives less than what is owed, you will not be liable for the deficiency. Even years after the bankruptcy is filed, you can walk away from the property with no personal obligation. Continuing to make your monthly payments after the bankruptcy has been discharged does not reinstate your personal liability on the loan(s).
Let’s consider the following fact pattern. Client 1 owns a house that is worth $200,000 and is encumbered by a mortgage of $310,000. Client 1 files a chapter 7 bankruptcy on January 1, 2011 and receives a discharge on April 8, 2011. Client 1 later loses her job and is unable to continue making the mortgage payments. On May 1, 2013, Client 1’s home is sold at a foreclosure sale for $150,000 (she owed $300,000 at the time).
If Client 1 filed a reaffirmation agreement for the mortgage (that was approved by the court), Client 1 would now be responsible for a $150,000 mortgage deficiency. Moreover, Client 1 may not file another chapter 7 bankruptcy to eliminate the debt until January 1, 2019. If Client 1 does not file a reaffirmation agreement, she will walk away from the home with absolutely no liability.
Benefits of a Reaffirmation Agreement
In my opinion, there are only a couple of situations in which a reaffirmation makes sense.
The lender gives you a better deal
In some situations, the lender will entice you to sign the reaffirmation agreement by reducing your principal balance or your interest rate. This is not a very common occurrence. Depending on what the reduction is, this may be one reason to agree to a reaffirmation.
On time payments reported to the credit bureaus
Lenders will usually try to convince you to sign a reaffirmation agreement by telling you that they do not have to report your on-time payments to the credit bureaus. This may by tempting to some, since on-time payments for secured debts will help improve your credit scores after bankruptcy. Please be aware that credit reporting will not always improve your credit scores. If you are late or miss a secured payment, these payments will be reported appropriately and will negatively impact your credit scores.
The greatest benefit of filing a bankruptcy is the fresh start you get by eliminating the debts that are weighing you down. Reaffirmation agreements are in direct conflict with the idea of a fresh start. Reaffirmation breathes life into an obligation that has been eliminated as part your bankruptcy. More often than not, creditors will try and persuade you to sign a reaffirmation by misrepresenting the benefits. The truth is, most reaffirmation agreements only provide minor benefits (if any) and could leave you with a major financial hardship.