Keeping Property in Chapter 7 by Reaffirming Secured Debt

by: Baran Bulkat, Attorney

In a Chapter 7 bankruptcy, you must disclose whether you intend to keep or surrender (give back) certain properties such as your house or car. However, even if you want to keep a property and continue paying on it, your lender may choose to take it back unless you "reaffirm" the debt. Read on to learn more about the pros and cons of reaffirming your debts.

Chapter 7 Bankruptcy And Secured Debts

A Chapter 7 bankruptcy wipes out your personal liability on all dischargeable debts including your mortgage and car loans. However, if your lender has a lien on your property (this is usually the case if you have a mortgage, car loan, or household goods purchased with in-store financing), the lien remains attached to the property and the lender can still repossess or foreclose on it if you don't make your payments. Debts like these, in which you pledge property as a guarantee that you will repay the loan, are called secured debts.

In certain instances, a lender may repossess secured property even if you are current on your payments unless you reaffirm the debt.

How Does Reaffirmation Work?

When you reaffirm a debt you essentially sign a new agreement that makes you personally liable on that loan again. This means that you are foregoing the benefit of your bankruptcy discharge on the reaffirmed debt.

Reaffirming a debt should not taken lightly. Be sure to evaluate all of your options carefully and understand the consequences fully before deciding to reaffirm any debt. However, you must decide quickly because reaffirmation agreements must be filed with the court no later than 60 days after your 341(a) meeting of creditors.

Why Would You Reaffirm?

Here are some reasons why you might want to reaffirm a secured debt.

To Rebuild Your Credit Sooner

When bankruptcy wipes out your personal liability on a loan, the creditor usually no longer reports your payment history to the credit reporting agencies. So even if you continue to make your mortgage or car payments after the bankruptcy they will not appear on your credit report and will not help improve your credit score. Reaffirming assures that your lender will continue to report your payments to the credit reporting agencies, which in turn helps you to rebuild your credit sooner.

To Receive More Favorable Loan Terms

When you reaffirm a debt, you are signing a whole new contract which means that you are free to negotiate terms that are more favorable than your initial agreement. Lenders may offer a lowered interest rate or a reduced principal balance to persuade you to reaffirm.

To Protect Against Repossession

Even if you continue to make timely payments, your lender can still take your property back if you fail to reaffirm the debt. While many lenders are happy to receive your payments and let you keep the property without a reaffirmation, some (especially certain car lenders) will still repossess your property. Reaffirming protects against the possibility of getting your property repossessed when you are still making timely payments.

Why You May Not Wish To Reaffirm

If you don't reaffirm, the worst thing a creditor can do is repossess your property. However, when you reaffirm and fail to make payments, the creditor can repossess the property and then sue you for a deficiency afterwards. This means that if you owe $8,000 on a property worth $5,000 and the lender repossesses and sells it for $5,000, it can sue you for the deficiency of $3,000 (the difference between the loan balance and the sale price) if you reaffirmed this debt. So if your property is significantly underwater (the balance of the loan exceeds the value of the property) then it may not be in your best interest to reaffirm.

In contrast, if you don't reaffirm the debt and the lender repossesses the property, it cannot go after you for the deficiency. Liability for the deficiency is wiped out with the Chapter 7 discharge.

What If I Don't Reaffirm?

Even if you don't reaffirm, many lenders (with a few exceptions) will still let you keep the property as long as you make timely payments on the loan. However, you should make sure that your lender will not repossess your property before deciding not to reaffirm if you cannot afford to lose it.