September 21, 2014

Should You Reaffirm Your Mortgage Loan in Chapter 7?

mortgage reaffirmation in Chapter 7When it works as planned, Chapter 7 serves to discharge (wipes out) your unsecured debt, while allowing you to keep most or all of your property.   If you have secured debt in your Chapter 7, you generally have the options of:

  • surrendering your property and walking away from any associated debt
  • redeeming your property by paying the secured creditor the fair market value in one lump sum
  • reaffirming your property by re-entering into a contract to pay the installment note
  • continuing to pay the note but not signing a reaffirmation

There are pros and cons for each of these options.   In this blog post I want to discuss the good and bad of reaffirming your mortgage debt.

Many lawyers feel very strongly that you should never reaffirm your mortgage.   When you reaffirm, you are obligating yourself personally to pay your mortgage note.   This means that if you should default on this obligation and the value of your home is less than the outstanding balance (a very real possibility in current economic times) you could find yourself facing a deficiency claim in the tens of thousands of dollars.

A better option, according to the anti-reaffirmation argument, is to “stay and pay” – in other words, stay in your home, continue to make regular mortgage payments and continue to build equity.  If you should lose your job or your ability to pay your monthly mortgage obligation, you can simply walk away, since your Chapter 7 discharge will have discharged your personal liability to the mortgage company.

The mortgage company would still have the right to foreclose against your property since your bankruptcy discharge does not cancel the security note linking the property and the mortgage loan.

What is the argument in favor of reaffirmation?

In my view there are three reasons to consider reaffirming a mortgage obligation:

  1. when you reaffirm, your timely payments will appear on your credit report and support your credit recovery.  If you do not reaffirm, you have no personal liability to pay the mortgage debt; thus all those payments you make will not positively impact your credit report
  2. when you reaffirm, you will have certainty in your relationship with your mortgage company.  While it is true that mortgage companies currently would rather have your money than your property, this may not always be the case.  Technically, your bankruptcy filing constitutes a default of the promissory note associated with your mortgage and, in theory, at some point in the future, your lender could decide to pursue a foreclosure or demand a higher interest reate even if you have been making your payments.
  3. technically the Bankruptcy Code does not permit “stay and pay.”   Section 521(a)(2) of the Code requires you to state your intention – surrender, reaffirm or redeem and fulfill that intention before your case is over.   Currently the Bankruptcy Courts are not enforcing this debtor obligation but a compelling Circuit Court or Supreme Court decision addressing this omission could drastically change the bankruptcy landscape.

Under provisions of the Bankruptcy Code, your lawyer is obligated to advise you regarding the pros and cons of reaffirmation.  Your lawyer will correctly be concerned about your capacity to make ongoing payments.  But current financial capacity is only one of the factors to discuss.   Your decision about whether to reaffirm ought to include a consideration of your short and long term financial prospects as well as the importance to you of the positive credit impact arising from reaffirmation.