If you own a home and file for Chapter 7 bankruptcy, your lender might ask you to sign a reaffirmation agreement. Here’s what it means, and why you may want to think twice.
When you file for Chapter 7 bankruptcy, your personal responsibility for paying your mortgage will be wiped out.
That doesn’t mean your mortgage disappears, however. What it does mean is that your can’t be held responsible for any shortfall if you fall behind and the lender sells the property at a loss.
In California, you can’t be held liable for the shortfall on a first mortgage anyway. But in New York as well as elsewhere, without a bankruptcy discharge the lender could sue you for the deficiency.
Confused? You’re not alone.
Home Loans – Two Obligations
When you take out a mortgage, you’re actually doing two things: signing a Promissory Note and a Mortgage (which in some places is called a Deed of Trust).
The Promissory Note is a document that obligates you to repay the debt with interest over time, spelling out your rights and responsibilities.
The Mortgage, however, is merely a document that serves as a lien against your property. It’s filed as a public record so that you can’t sell without satisfying the Promissory Note.
More to the point, it is the Mortgage that the lender will use to foreclose on the property in the event that you fail to live up to your obligations under the Promissory Note.
Chapter 7 Bankruptcy Affects Only One Document
When you file for Chapter 7 bankruptcy and get a discharge, your personal responsibilities under the Promissory Note are wiped out.
The Mortgage, however, remains unaffected. The lien stays against your property, and the lender will use it if you don’t make your payments.
In that way, you’re still sort of liable on the Promissory Note. If you don’t care about keeping the property, don’t make payments. But if you want to keep it, you need to keep sending your money.
Reaffirmation – A New Promise to Repay
Rather than voluntarily making payments on the mortgage after you file your Chapter 7 bankruptcy case, you or your lender may look at a process called reaffirmation.
Reaffirmation is a legal term, but it loosely means a new promise to repay a debt after bankruptcy that otherwise would be wiped out. You and the lender sign an agreement that’s approved by the bankruptcy judge, and it becomes binding on you after your case is completed.
The agreement may also signed by your bankruptcy lawyer if you’ve got one, but that’s not necessary. Your lawyer’s signature may quicken the process by eliminating the need for court approval, but lots of lawyers won’t sign them (for example, I do not sign reaffirmation agreements).
In addition, a fair number of bankruptcy judges won’t sign a reaffirmation agreement because it’s not necessary in order for you to keep the property.
If you’re hellbent on reaffirming the mortgage, be prepared to face some tough questions in your quest to convince the judge that it’s a good idea to do so.
Why You May Care About Reaffirming Your Mortgage
If you discharge your personal liability to the mortgage company in Chapter 7 bankruptcy, they may not let you refinance with them in the future. But you do realize that there are lots of other banks out there, right?
After you discharge your mortgage obligations, the lender isn’t allowed to report your payments to the credit reporting agencies. Of course, there are other ways to prove to the world that you’ve been making your payments.
Aside from those two reasons, I have no idea why you’d want to reaffirm a mortgage debt. After all, you’re still allowed to pay the mortgage after bankruptcy,
How Long You Have To Reaffirm A Debt
A reaffirmation agreement must be signed by both parties and approved by the bankruptcy court before the discharge is entered.
Once the discharge is entered, the bankruptcy judge doesn’t have the authority to sign the agreement.
If you’re going to do it, best to get the process started as soon as the case is filed.
What If You Want To Reaffirm After Bankruptcy?
You can’t reaffirm your mortgage once the bankruptcy case is over without jumping through some additional hoops.
You’re going to need to make a motion to the bankruptcy court to reopen your case for the limited purpose of entering into a reaffirmation agreement.
Some courts will allow you to do so, others will not permit it.
A Tool For Limited Use Only
Reaffirmation is seldom a good idea, and for a mortgage it can be a downright stupid one.
That said, I’m sure there are some situations that call for reaffirmation of a mortgage. I don’t think I’ve seen one in nearly 19 years of practicing bankruptcy law, but there’s always a new twist to be considered.
If you’re looking to go down the reaffirmation rabbit hole, talk with your lawyer first. If you filed for Chapter 7 bankruptcy on your own, this would be a good time to sit down with an attorney if only to review your options with respect to the mortgage.