Should You Reaffirm Secured Debt in Chapter 7 Bankruptcy?

You should reaffirm a secured debt in Chapter 7 bankruptcy only if you truly need to keep the property and the creditor will agree to fair terms, and you can't afford to redeem it by paying for its value outright. A reaffirmation agreement is a new, legally binding contract that keeps you personally responsible for a debt that bankruptcy would otherwise eliminate.

Why You Might Need a Reaffirmation Agreement

Chapter 7 bankruptcy affects types of debt differently. Some, called "nondischargeable debts," survive bankruptcy. Typically, these include recently incurred back income taxes, child support obligations, and student loans (unless you can prove undue hardship). Most other debts—including your personal liability on secured debts like car loans—get discharged (wiped out) at the end of your Chapter 7 case. (11 U.S.C. § 727.)

After the court issues the bankruptcy discharge, the creditor can't sue you to collect the debt. However, because the creditor still has a lien on the property that secured the debt (the car or other property), it can repossess or otherwise take the collateral if you fall behind on payments, even after your case is over. In other words, bankruptcy eliminates your responsibility to pay a debt. But if the creditor has a lien against property you were still paying on, the lender might require you to enter into a new contract to keep it, called a reaffirmation agreement. (11 U.S.C. § 524(a).)

When to Consider Reaffirming a Debt

Reaffirming a secured debt makes sense only in narrow circumstances. For instance, consider it if you really can't do without the property, you can't afford to redeem it, and the creditor will accept its current value as full payment on the debt. Outside of those circumstances, redeeming or surrendering the property is usually the smarter move.

Keep in mind that reaffirmation agreements are routinely entered into for vehicle loans, but rarely in other circumstances, for reasons your bankruptcy lawyer can explain. Also, you'll need to meet other requirements to keep a financed car in bankruptcy.

Downsides to Reaffirmation of Debt

The biggest downside is that 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'll 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.

Advantages to Reaffirmation of Debt

The main advantage is that reaffirming lets you keep the property securing the debt without making a lump-sum payment, which can be a real benefit if you rely on that property, such as a car you need for work.

Options for Dealing With Secured Debt

Besides the reaffirmation agreement route, you have other ways to handle secured debt in Chapter 7. You can redeem the property in a lump-sum payment equal to its value, which is a good approach when you owe more than the item is worth and can afford to pay its value in full. If you don't want to keep the property at all, you can simply surrender it to the creditor, which wipes out the debt without any further payments on your part. (11 U.S.C. § 722.)

In some jurisdictions, vehicle lenders will let you keep the vehicle without a reaffirmation agreement as long as you stay current on payments. This isn't a court-approved method, so it comes with no protections: the lender can recover the vehicle at any time, though you can also return it at any time and owe nothing.

The table below compares your three court-sanctioned options for handling secured debt in Chapter 7.

How Reaffirmation of Debt Works

To reaffirm a debt, you and the creditor sign a written reaffirmation agreement and file it with the court on official forms. The forms are Official Form 427 (the reaffirmation cover sheet) and Official Form 2400A (the reaffirmation agreement and required disclosures). If you're dealing with a large creditor, it will probably handle the paperwork and ask you to sign it.

Before you sign, the creditor must give you a set of disclosures explaining the amount of debt being reaffirmed, the interest rate, and the fact that reaffirming means your personal liability for the debt won't be discharged. You also have the right to cancel (rescind) the agreement at any time before discharge or within 60 days after it's filed with the court, whichever is later. (11 U.S.C. § 524(c)(4), (k).)

After you file the agreement, if you don't have a lawyer who will certify that the payments won't create an undue hardship and are in your best interest, you'll typically have to file a separate motion (Official Form 2400B) and appear at a hearing before the bankruptcy judge for approval. Where court approval is required, the judge is unlikely to approve your reaffirmation agreement if:

• you won't 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, or
• the loan isn't really secured.

Talk to a Lawyer Before You Sign

Before signing a reaffirmation agreement, it's worth seeking advice from an experienced bankruptcy lawyer, especially for high-value debts like car loans. The lawyer can help you figure out whether the numbers make sense and negotiate better terms with the creditor before you commit to years of payments on a debt bankruptcy would otherwise erase.

Related Reading

Reaffirmation is just one piece of how Chapter 7 treats debt secured by property. These related articles can help you decide your next move:

• find out whether Chapter 7 bankruptcy can stop a car repossession
• learn more about what happens to liens in Chapter 7 bankruptcy, and
• see how secured and unsecured debt are treated differently in Chapter 7.