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23 January 2013

Why Reaffirm?

I have blogged in the past about why it is critical to disclose all of your debts on your bankruptcy schedules, even ones you don't want to include or "file against".  I didn't realize how long ago it was that I wrote that article, so it is probably due for a refresher.  You can read the full article here.  The two main things to take away from that article are:
  •  Listing a debt is NOT the same thing as "filing against" or discharging a debt.
  • You have an obligation to disclose all creditors - dischargeable or non-dischargeable, secured or unsecured - as a matter of due process.
So, with that in mind, let's move on to the topic of reaffirmation agreements.  Again, there are two main points to make in order to understand why a reaffirmation agreement may be necessary.
  • Bankruptcy wipes out debts, but it does not remove liens (with some exceptions).
  • Secured debts are generally dischargeable debts.
All right, so let's put ourselves in an alternate reality where there is no such thing as a reaffirmation agreement, but all other bankruptcy laws are the same.  You file for bankruptcy and receive a discharge.  The discharge is good against the world.  Therefore, your mortgage and car loan are discharged.  This means that you have no obligation to pay the mortgage company and vehicle lender, and they have no legal right to pursue you for payment.

However, bankruptcy did not wipe out the security interest that existed.  In the absence of payment, the vehicle lender repossesses your car and your mortgage company forecloses on your home.

Enter the reaffirmation agreement.  A reaffirmation is a post-petition affirmation of a debt.  In a way, it converts an existing, pre-petition debt into a post-petition debt, and makes it non-dischargeable under the old bankruptcy.  (It can be discharged in a future bankruptcy, provided that enough years lapse such that you are eligible for a discharge.)

Reaffirmation agreements are voluntary and must be entered into by both parties - the creditor and the debtor.  A debtor who wishes to reaffirm cannot force an unwilling creditor to enter into a reaffirmation agreement.  A creditor who wishes to reaffirm cannot force an unwilling debtor to enter into a reaffirmation agreement.

So, what are some of the advantages and disadvantages to reaffirming?

First, reaffirming a secured debt allows you to keep the collateral so long as you continue to make payments on the loan.  A failure to reaffirm does not necessarily mean that you lose the collateral (you can make payments without a reaffirmation, which we refer to as a "ride through"), but there are some creditors who consider a failure to reaffirm as a default, and sufficient cause to foreclose or repossess.

Second, reaffirming a secured debt is an excellent way to rebuild credit after bankruptcy, because you don't have to apply for a new loan - it already exists, and the payments you make on it after your case is filed will help boost your credit score.  In the absence of a reaffirmation agreement, however, creditors are not obligated to report your payments to the credit bureaus.

Third, if you file a reaffirmation agreement, but then default on the loan later, the creditor is not only able to repossess or foreclose, but the creditor can also sue you for full payment of the deficiency balance afterward.  Your bankruptcy discharge won't protect you.  Whereas, if you do not file a reaffirmation agreement, but later default on the loan, you still face the foreclosure or repossession, but won't be liable for the deficiency.

Here are a few other things to consider when making an informed decision to reaffirm a debt or not...

Creditors are generally under no obligation to repossess or foreclose a property if they do not want to.  Although this is uncommon with real estate and vehicles, if this does happen, you could remain liable for things like property taxes, liability insurance, winterization and heating costs, parking violations, and so forth.  If you cannot get a creditor to physically take the keys to real estate or a vehicle, you probably should not abandon the collateral until they actually come for it.  And don't just sell the collateral, either.  The lender could come back later for the collateral, and if it isn't available for collection, you could be assessed criminal penalties.  Property that has a lien on it should never be sold without the lender's express consent and - ideally - a lien release.

For smaller secured loans (like furniture loans, appliance loans, and jewelry loans), although the creditors have the right to repossess if you default or do not sign the reaffirmation agreement, it is highly unlikely that they actually will.  The costs of repossession almost always outweigh the price the lender will realize at auction.

Creditors who claim to have security in stuff you buy might not necessarily have a valid purchase money security interest (PMSI).  Best Buy is notorious for having very vague security agreements which list as security "all of the debtor's assets" or "all the debtor's personal property" or "all items purchased".  Under Wisconsin law, 409.108(3) of Wisconsin statutes indicates that generic descriptions are okay for finance agreements, but not sufficient for security agreements.  There needs to be some reasonable detail of the collateral.

If you do want to reaffirm, the agreement must be filed with the Bankruptcy Court within 60 days of the date of your 341 hearing (which is when you are scheduled to receive your discharge).  Your case cannot be reopened to get a late-filed reaffirmation approved.  (You can file a motion to delay discharge to allow more time to complete a reaffirmation agreement.  You can also reopen a case to file a reaffirmation agreement after discharge, but the court will not approve it, and at the expense of a $260 filing fee.)

Notwithstanding considerations of positive credit reporting and eliminating the risk of foreclosure and repossession, there are other things you should consider before filing a reaffirmation agreement.  Most notably - can you afford it?  Often overlooked is the budget, but what good is a fresh start in bankruptcy if you're just going to dig yourself into a new hole with something you cannot afford.  Consider the following factors:
  • What is the monthly payment?  Can I afford to pay it?
  • What is the interest rate?  Could I get a new loan for this sort of collateral at a better rate?  How much of my payment is actually going to the principal balance?
  • What is the term of the loan?  Do I have to make this payment for 6 months or 30 years?
  • How much is the collateral worth?  Does it make sense to pay $20,000 for a car that is worth $6,000?  Might it be cheaper to finance a new car?
  • Is the collateral necessary?  Sure, I love my 72" plasma television, but is paying $200 a month for it really worth it when I have a wife and two kids to feed?