Keeping Property in Chapter 7 by Reaffirming Secured Debt

In a Chapter 7 bankruptcy, you must disclose whether you intend to keep or surrender certain properties, such as your house or car. However, even if you want to keep a property and continue paying on it, your lender might decide to take it back if you don't “reaffirm” the debt by entering into a new contract to replace the one unwound in Chapter 7. 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, which is usually true if you have a mortgage, car loan, jewelry, electronics, or household goods purchased with in-store financing, the lien remains attached to the property.

The consequence of having a lien on the financed property is that the lender can repossess or foreclose on it if you don’t make your payments, including if you eliminate the loan in bankruptcy. Debts like these, in which you pledge property to guarantee that you will repay the loan, are called "secured debts."

How Does Reaffirmation Work?

When you reaffirm a debt, you essentially sign a new agreement that makes you personally liable for that loan again. Essentially, you forgo the benefit of your bankruptcy discharge on the reaffirmed debt by agreeing to be responsible for paying it again.

Reaffirming a debt should not taken lightly, and you should understand the consequences. It's a good idea to make the reaffirmation decision before filing because reaffirmation agreements must be filed with the court no later than 60 days after your 341 meeting of creditors, the one meeting all filers must attend.

Why Would You Reaffirm a Secured Debt?

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 enables you to rebuild your credit sooner.

To Receive More Favorable Loan Terms

When you reaffirm a debt, you are signing a whole new contract, so you are free to negotiate more favorable terms than your initial agreement. Lenders might offer a lowered interest rate or a reduced principal balance to persuade you to reaffirm, but the terms remain the same in most cases.

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.

Learn about reaffirming a car loan.

Why You Might Not Want To Reaffirm

If you don’t reaffirm, repossessing your property is the worst thing a creditor can do. For instance, if the car needed major repairs or you didn't want it any longer, you could walk away without penalty. That's not the case after reaffirmation. If you fail to make payments, the creditor can repossess the property and sue you for a deficiency afterward.

For instance, suppose you owe $8,000 on a property worth $5,000, and the lender repossesses and sells it for $5,000. Depending on your state's laws, the lender might be able to 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), reaffirming might not be in your best interest.

However, if you don't reaffirm the debt and the lender repossesses the property, the lender can't go after you for the deficiency. Liability for the deficiency is wiped out with the Chapter 7 discharge and remains so unless you sign a new contract giving the lender deficiency rights.

Learn about eliminating deficiencies in bankruptcy.

Keeping Property When You Don’t Reaffirm

Even if you don’t reaffirm, many lenders, with a few exceptions, will let you keep the property as long as you make timely payments on the loan. However, your lender can repossess your property anytime if you don't reaffirm, and there's no way to prevent it without a contract. And while you can walk away at any time without fear of a deficiency judgment, the benefit might not be worth the risk if you can't afford to lose the property.

Additional Requirements for Keeping Property in Bankruptcy

If you sign a reaffirmation agreement, you won't need to worry about losing the car to the lender in Chapter 7 bankruptcy. But it isn't the only thing you must do to safeguard the property. You must also be able to "exempt" or protect the property equity with a bankruptcy exemption.

If you're a homeowner, you'll want to learn about filing for Chapter 7 with equity in a home. Also, it's important to understand everything necessary to prevent losing a car in bankruptcy. Otherwise, the Chapter 7 trustee will sell the property for the benefit of your creditors.

Attending the Reaffirmation Hearing

If you choose to enter into a reaffirmation agreement, someone must review it to ensure it is in your best interest and won't cause you or your family undue hardship. If a bankruptcy lawyer represents you, your attorney can review and sign it. If a bankruptcy attorney doesn't represent you, you must appear before a bankruptcy judge and receive approval at a reaffirmation hearing.