Monday, May 9th, 2011
Most people know that Chapter 7 allows you to wipe out unsecured debt – credit card bills, medical debt and other signature loans. But what about secured debt – loans you are still paying to finance your home, your car, perhaps some jewelry or furniture?
This past March, I discussed redemption of property in Chapter 7. Redemption of property is a viable option but it is far less common than "reaffirmation" of debt.
Why Do You Need to Reaffirm?
Secured loans actually contain two different kinds of obligations. On one hand, you obligate yourself personally to pay a particular debt. This is typically in the form of a promissory note. The second layer of obligation ties the specific item of property to the loan. This is called a security agreement.
When you file a Chapter 7 and a discharge is issued by the judge, your personal liability on your secured debt is extinguished. This is why payments on a non-reaffirmed car loan or home loan will not be reflected on your credit reports. You have no personal obligation to pay. However, a Chapter 7 discharge does not extinguish the lender's security interest against property. This is why a vehicle lender can repossess or a mortgage company may foreclose to recover property. In such a situation you would not have any personal liability for any deficiency amount.
A reaffirmation serves two main purposes:
- you will have the certainty of knowing that you are once again in a contractual relationship with the lender. If you do not reaffirm, you could wake up one day to find that your vehicle has been repossessed or that you are being foreclosed upon.
- secondly, payments on a reaffirmed debt will appear as positive information on your credit reports. This means that your credit score will recover more quickly
Can You Negotiate Better Terms in a Reaffirmation?
Because a reaffirmation agreement is a new contract between you and your lender, you absolutely can negotiate different terms. I have negotiated reduced payments, lower interest rates and reduced balances on furniture, electronics, and vehicles. I have also negotiated lower payments on 2nd and 3rd mortgages.
It has been my experience that some lenders will just not play ball. They would rather incur the expense of recovering, storing and reselling a used item. I think this attitude of "we do not negotiate with debtors" is silly and counterproductive, but some lenders take this position (I suspect that some of these lenders do not have the staff or protocol for handling a negotiated debt).
On the other hand, many lenders will agree to a deal with terms a lot better than the original contract. But you do have to ask, and, of course, if you agree to any terms, you must live up to the deal. Reaffirmation agreements can be canceled by the debtor within 60 days after the agreement is entered, or the case is closed, whichever comes first.
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Tuesday, August 3rd, 2010
I recently received an email from a blog reader asking about his obligations to his mortgage company when he does not reaffirm:
I have read your blog and you are very through so I write you with hopes that you might answer this question for me. I file Chapter 7 in 08, and did not reaffirm my loan. I am still living in the house and did make some payments. However, i have not for the last 8 months. It is my understanding that I must sign a document to reaffirm and that continuing payment in itself is not a reaffirmation…or? Well it gets a little more complicated. My house is valued at $410,000 and the bank has offered me a deal that is going to be hard to refuse. They have agreed to let me do a short re-fi in the amount of 180k. If I agree to that is that in itself a reaffirmation?
Here is my response: in most cases, when you take out a mortgage loan, you are signing two different types of agreements. The first type is a promissory note whereby you personally agree to make the payments. The second type of obligation creates a property lien, meaning that you, as the owner of the property, pledges that property as collateral for the loan.
When you file a Chapter 7 and receive your discharge, your personal obligations are extinguished. However, a Chapter 7 discharge does not eliminate the mortgage company's lien against your property. If you "reaffirm" your mortgage, you are actually reaffirming the promissory note and your personal obligations to pay.
For years, many bankruptcy attorneys advised their clients to avoid signing reaffirmation agreements for mortgages, car loans or any other secured debt. The reasoning – even without a personal "guarantee" lenders are protected by the property lien. If the lender is willing to accept payments (the so-called "stay and pay" option), the now discharged debtor keeps his property, keeps making payment, but does not have personal liability on the note.
If the debtor misses payments, the lender would still have the right to foreclose or repossess based on the property lien. The debtor would not have personal liability for any foreclosure or repossession deficiency because his personal liability was extinguished in the bankruptcy.
There is a downside to this "stay and pay" strategy. First, the debtor does not get any credit report benefit for making payments. Because the debtor's personal obligations have been extinguished, the lender no longer reports either a positive or a negative payment history. A positive payment history from a mortgage company can be a good way to restore credit after bankruptcy, and if you do not reaffirm, you will not get this benefit.
Second, there is the "uncertainty factor" if you do not reaffirm. Most mortgage or vehicle finance installment notes contain a default provision that includes bankruptcy as a default trigger. In theory, at least, once your bankruptcy is closed (and the automatic stay of bankruptcy terminated), your lender could declare your loan in default and take action under State law to recover the collateral. In my experience, lenders would much rather have monthly payments than your collateral but this risk does exist.
Finally, many of my readers have asked me if there is such a thing as "constructive reaffirmation" meaning that by making payments, are you in effect re-obligating yourself? Are you creating a contractual obligation by your actions?
I think that the answer to this depends on State law but I would suspect that a mortgage or vehicle lender would have a hard time making this argument. In many States (such as in Georgia) a financial obligation related to real estate must be written and they must have specific terms. As a matter of general contract law, a contract usually will not be enforceable if its terms are not specified. I would argue therefore that a debtor's actions of simply making payments and the lenders actions of accepting such payments should not be enough to create personal liability on the part of the debtor. I would be interested to know if any of the attorneys who read this blog have a different opinion or if anyone is aware of any case law that says otherwise.
At a minimum, if a lender tries to make the argument that you have somehow re-obligated yourself personally by your act of making payments, I would insist that the lender provide you with case law or other support for its position, and you should consult with a lawyer before agreeing to any payment or taking any action (like signing a new, valid contract) that could create personal liability.
My reader states that his lender has proposed a refinance for $180,000. He did not say, but I presume that his prior (discharged) mortgage was much higher than this and that his current payments under the "stay and pay" are based on this higher balance. If he enters into a mortgage contract for $180,000, that contract will function like any other mortgage – and include both personal liability under a promissory note as well as a property lien. It is not a reaffirmation because the bankruptcy is over – instead, the proposed $180,000 loan deal is equivalent to a new mortgage. This proposed deal could result in lower payments plus positive credit history, but it will also create personal liability that currently does not exist. I would certainly advise my reader to discuss his options with an attorney so that he will fully understand the implications of his decision.
Posted in Chapter 7 issues, Lenders, Mortgage, Mortgage modifications, Obligation, Post bankruptcy credit rebuilding, Reaffirmation and negotiation, a, actions, agreements, and, avoid, clients, contract, create, creates, enters, history, history , liability, liability my, lien, making, mortgage loan reaffirmation, negative, note, payment, payments, personal, positive, promissory, property, reader, reaffirmation, reaffirmation after bankruptcy, reaffirming, refinance and bankruptcy, signing, simply, states, the, type | Comments Off
