Except for certain types of debt that survive bankruptcy such as back taxes and child support obligations, most of your debts will be discharged (wiped out) at the end of your Chapter 7 bankruptcy case. If you owe secured debts (debts for which you have pledged property as collateral), your personal liability for those debts will be discharged in bankruptcy too.
This means the creditor can't sue you to collect the debt. However, the creditor still has a lien on the property that secured the debt. So, even though your personal liability to repay the debt is gone, the creditor can still repossess or otherwise take the collateral if you fall behind on your payments, even after your bankruptcy case is over. If you want to keep the property after bankruptcy, you may need to enter into a reaffirmation agreement with the creditor.
To learn more about how Chapter 7 bankruptcy affects different types of debt, see Your Debts in Chapter 7 Bankruptcy.
Options for Dealing With Secured Debt
So what should you do if you want to keep property that secures a debt? You have several options. If you can afford it, you can redeem the property by paying the creditor what it's worth. Many debtors can't afford redemption, however. Another option is to sign a reaffirmation agreement: a contract with the creditor agreeing that you will still owe the debt after your bankruptcy is over.
Reaffirmation goes against a primary purpose of bankruptcy, which is to give the debtor a clean financial slate. On the other hand, it can be useful to debtors who really need to keep a particular item (typically a car) and can't come up with the money to redeem it. To make sure debtors are making smart choices (and not bowing to improper pressure from creditors), bankruptcy law requires bankruptcy judges to review and approve most reaffirmation agreements.
When to Consider Reaffirming a Debt
Before reaffirming a secured debt, consider the pros and cons.
Advantages to reaffirmation. Reaffirming a debt allows you to keep the property securing the debt, which can be a real advantage in some cases. It also allows you to avoid having to come up with a lump-sum payment to keep the property.
Downsides to reaffirmation. On the other hand, reaffirmation leaves you stuck with the debt. If you can't make the payments you agreed to, the creditor can repossess the property, plus you will be liable for the difference between what you owe on the property and what it's worth when repossessed. And, because you've already filed for bankruptcy, you'll have to wait another eight years before you can use Chapter 7 again to wipe out the debt.
That's why you should consider reaffirmation only if:
- you really, really can't live without the property
- you can't afford to redeem the property, and
- the creditor will agree to accept the current value of the property as payment in full on the debt, even if you owe more when entering bankruptcy. Creditors know that if you don't reaffirm and they have to repossess, store, and sell the property, they will end up with even less than its current value, so they may be willing to negotiate (except on a mortgage).
How Reaffirmation Works
To reaffirm a debt, you and the creditor agree to the terms of the new debt in a written reaffirmation agreement, which is filed with the court. You must file two court forms: Form 27 (the reaffirmation cover sheet) and Form 240A (the reaffirmation agreement itself.) If you're dealing with a large creditor, it will probably handle the paperwork and ask you to sign it.
After you file the agreement, you will typically have to appear at a hearing before the bankruptcy judge, who will decide whether or not to approve it. The court can disapprove the agreement if it appears to be an undue hardship on you or isn't in your best interest.
In most cases, the court is unlikely to approve your reaffirmation agreement if:
- you will not have enough money left, after paying your other expenses, to make the required monthly payments under the agreement
- the property is worth significantly less than the balance of the loan you want to reaffirm
- the interest rate in the agreement is too high, and
- the loan isn't really secured. (For example, if you have a second mortgage on your home, but you owe more on your first mortgage than the home is worth. Also, depending on where you live, many bankruptcy judges will not approve reaffirmation agreements for mortgages altogether.)
Finding Bankruptcy Lawyers
If you are considering reaffirming a significant debt, you may want to consult with an experienced bankruptcy lawyer first. You may have other options that won't leave you deeply in debt after your bankruptcy is over.