SHOULD I REAFFIRM MY MORTGAGE AGREEMENT AFTER MY CHAPTER 7 BANKRUPTCY?
Updated: Jun 10, 2020
Getting thru a Bankruptcy, no matter the Chapter, is an experience a person will soon not forget. The individual filing the petition is known as the petitioner or debtor. The process of successfully preparing and filing any Bankruptcy petition, no matter the chapter, will cause a person to breathe a sigh of relief. Of course, the sigh of relief and satisfaction the petitioner feels is due to their new status of being debt free. The petitioner has achieved the Fresh Start that the Bankruptcy process was created for. Now petitioners can continue their lives without the burden of debt that caused them difficulties.
In Bankruptcy, individuals filing for personal bankruptcy will have a choice between either a Chapter 7 Bankruptcy Petition or a Chapter 13 Bankruptcy Petition. The Chapter 7 petition is the most desirable due to the fact that debtors can walk away from their debts without any payment to creditors. Most debtors would prefer to file a Chapter 7 petition because once they receive their discharge they owe nothing and truly get a quick Fresh Start.
In the alternative, the debtor can file a Chapter 13 Bankruptcy. Under the Chapter 13 Bankruptcy rules, the debtor’s income is evaluated to see if they can support their reasonable living expenses while also making monthly payments to the Bankruptcy Trustee. A Chapter 13 Bankruptcy petition is mainly for wage earners who have secured assets to protect. A secured asset is an asset that is secured by the asset itself like a home or a car. The employed debtor who has a home and/or other secured assets that they want to keep can chose this Chapter being assured they will get to keep their secured assets.
The only problem with a Chapter 13 is that the petition requires the debtor to pay a monthly payment toward their overall debts. The Chapter 13 debtor must pay each and every month for a period of 3 to 5 years. The petition rules will dictate whether they pay for 3 or 5 years and exactly how much the payment will be. However, at the end of the payment period, the debtor will be caught up on their debts and have their fresh start. The good thing being that the debtor has paid pennies on the dollar toward their back debts while at the same time protecting the secured assets that they want to protect.
When looking at the alternatives, clearly it makes sense to be able to get out of debt without having to pay anything to creditors. That is why most debtors would prefer Chapter 7 as opposed to a Chapter 13 Bankruptcy. Not only are you saving money with a Chapter 7, your case is done relatively quickly instead of waiting 3 to 5 years.
In Bankruptcy, each chapter has its own rules that the petitioner must follow. If a homeowner petitioner files a Chapter 7 wanting to keep their home, they must satisfy one major Chapter 7 rule requirement. The equity in the home must not be more than the Chapter 7 exemption rules allow. In other words, under the Chapter 7 rules, the petitioner will be able to protect only a certain amount of their home equity. The Chapter 7 rules clearly define the limits of the home equity the homeowner petitioner can protect. If the equity exceeds the home equity limit under the Chapter 7 rules, the Bankruptcy Trustee can liquidate the home and use the excess unprotected home equity to give to the petitioner’s creditors. You see, it is the Bankruptcy Trustee’s job to liquidate all unprotected assets of the debtor and give it to the creditors towards the debt the debtor owes.
The homeowner petitioner in a Chapter 7 must be able to successfully use the Chapter 7 exemption rules to protect their home equity or else they will lose their home in the Bankruptcy process. Thus, whenever a homeowner debtor with too much equity (more than the Chapter 7 rules allow him to protect), looks to file a Chapter 7 petition, he is basically making a choice between two alternative paths. The first is to file the Chapter 7 and walk away from the home, abandoning it to the Bankruptcy Trustee for liquidation. Then the Trustee can distribute all unprotected home equity to the creditors. The second choice is to not file a Chapter 7 petition at all and instead file a Chapter 13 Bankruptcy Petition whereby the debtor petitioner can protect their secured asset (home), but will have to pay over a 3 to 5 year period a certain amount towards their debts.
As can be seen from the above analysis, the debtor walks away from a Chapter 7 Bankruptcy relieved of their personal debt obligation toward their home if they qualify equity wise This is powerful, but exactly what obligation does the Bankruptcy clear the homeowner of? Mechanically, how does a Home Loan work and what are the obligations created when a person takes out a Home Loan? To answer this question, we must first analyze what exactly a person is doing when they acquire a Home Loan. What is a Home Loan anyway, and how does it bind the individual to the home and create a debt for the borrower?
Home Loans, commonly referred to as Mortgages, are instruments an individual must agree to if they want a lending institution to loan them money to purchase a home. Within the Agreement itself, the borrower must somehow promise to repay the loan. The lending institution also will have as part of the process some sort of guarantee that they will be repaid. The agreement will spell out the price the lender will charge in interest for it to make sense to loan the money to the borrower. Lenders are in the lending business to make a profit and obviously will not make a loan if it will not generate a profit for them.
The major parts of a Home Loan are the Promissory Note and the Mortgage itself. Thus, anyone who takes out a home loan is actually doing two things. They are actually signing a Promissory Note and a Mortgage. Lets look at each part individually. We are analyzing them to see what they are exactly and how a Chapter 7 Bankruptcy changes the borrowers obligation towards each one individually.
A Promissory Note is a device within the Home Loan that personally obligates the borrower to pay back the Home Loan to the lender. Think of it separately from the actual Mortgage itself. The Promissory Note is a personal obligation above and beyond the Mortgage and is not attached to anything other than the Home Loan. In other words, it is a personal obligation and promise by the borrower to repay the money that they were advanced in order to purchase the home in the first place. It is not attached to the property that is being purchased. It is merely a promise to repay the lender the money that they are loaning to the borrower.
When a person gets a Chapter 7 discharge, the Bankruptcy is only discharging the personal obligation of the borrower. Thus, when you get your Chapter 7 discharge, your personal obligation to repay is forgiven. This personal obligation is in the form of the original Promissory Note which is really the only thing that is forgiven by he Bankruptcy within the overall Home Loan (Mortgage) itself. All other parts of the Home Loan are left in tact and not affected by the Bankruptcy.
Our analysis will now turn to the actual Mortgage instrument itself. The Mortgage instrument is the part of the Home Loan that actually attaches to the property that is the subject of the Home Loan. As stated earlier, it is separate from the Promissory Note and still present even though the borrower has received their Chapter 7 discharge. The Mortgage instrument gives the lender the right to actually foreclose and sell the property it is attached to in order for the lender to reclaim the loan funds. This is why, even after the Chapter 7 Bankruptcy the lender can still foreclose on the Bankruptcy debtor’s home.
Chapter 7 Bankruptcy then, is really a process whereby the Bankruptcy debtor is achieving in actuality incomplete relief. Yes, they are relieved of the obligation to personally repay the Promissory Note. However, if they do not keep up their payments on the home, they could still lose it to foreclosure. The lender still has the Mortgage instrument itself, which is part of the Home Loan papers upon which it can foreclose.
Looking at reaffirmation then, why would a debtor sign such a document? What is the debtor doing by signing the reaffirmation agreement and what exposure does the debtor have before signing the reaffirmation agreement? What exposure does the debtor have after he signs the reaffirmation agreement?
Reaffirmation is basically a new promise to repay. The debtor has wiped out their personal obligation to pay the original debt under the Promissory Note by virtue of the Chapter 7 discharge. However, when the debtor reaffirms the secured debt by signing the Reaffirmation Agreement, he is making a new promise to pay the original debt. This wipes out the benefit the debtor received from the bankruptcy and reinstates the secured debt loan under the original contractual conditions. The debtor can reaffirm their loan having filed either a Chapter 7 or Chapter 13 Bankruptcy Petition.
Reaffirmation also can be detrimental to the debtor if the lender eventually sells the repossessed property at a loss later. You see, by wiping out the Promissory Note in the Bankruptcy process, the Bankruptcy debtor also is wiping out their personal obligation to make up any deficiencies in the amount recovered from any future sale. In other words, by virtue of the Bankruptcy discharge, the debtor can’t be held responsible for any future shortfall if they later fall behind on their payments again and the lender sells the property at a loss. By wiping out the discharge and reaffirming the original Promissory Note, the debtor once again is responsible for any and all obligations under the original Promissory Note. Paramount among these obligations is the obligation to make up any shortfall if the home is ever sold off by the lender after being repossessed at some future date. Thus, reaffirming the secured debt loan is a dangerous thing to do. The exposure to make up any shortfall in case the property is ever repossessed again is huge and makes it really a dangerous thing to do.
Once the debtor files for a Chapter 7 Bankruptcy, the lender will try to get the borrower to reaffirm the secured debt loan. The lender will try to get the debtor to agree to reaffirm the secured debt loan using various techniques to intimidate the debtor. Actually, since they cannot repossess unless and until the debtor defaults on payments, the lender is powerless to really hurt the borrower. Often, the lender will try to deny refinancing of the loan in the future just to make life difficult for the borrower for not reaffirming. This tactic only goes so far because there are many banks that will refinance out there in the market place.
In general, Reaffirmation Agreements are common and a tactic most lenders do in order to preserve their power over the borrower. The debtor (borrower) would be wise to avoid entering into any such agreement. There is little the lender can actually do to the borrower if they keep up their payments.
In balancing the pros and cons of Reaffirmation Agreements, the risks and dangers of entering into one far outweigh any benefit the borrower would get from the lender. Most experienced lawyers will do their best to persuade their clients to not sign a Reaffirmation Agreement. Also, a borrower will always be hard pressed to convince any Bankruptcy Judge to accept and approve a Reaffirmation Agreement.