May 24, 2017

Should I Keep Some of My Debts Out of Bankruptcy?

When people consider filing for bankruptcy protection, they often want to know if they can keep some of their debts out of their bankruptcy estate. In legal terms, this is called "reaffirming a debt."When people consider filing for bankruptcy protection, they often want to know if they can keep some of their debts out of their bankruptcy estate. In legal terms, this is called “reaffirming a debt.”

Reaffirmation means that the reaffirmed debt is not discharged in bankruptcy.  In other words, the Debtor voluntarily agrees that the debt will not go away. 

Beware reaffirming debts

What Debtors often don’t consider is that when they reaffirm a debt, they leave the creditor with the option of repossessing the property and suing the debtor for the balance owed in the event that the debtor defaults on the new contract.

In almost all instances, reaffirmations are done to enable the debtor to retain personal property that is secured by a mortgage lien. Reaffirmation decisions must be made at the time the bankruptcy case is filed and before the debts are discharged.

Personal property and reaffirmation

Many individuals in bankruptcy have a car payment, and perhaps also payments on furniture, appliances, jewelry, or computers.  This type of property is known as personal property.  A creditor that has a security interest, lien, on personal property can require a Debtor who wishes to keep the property to reaffirm the debt.

It should be noted that in many instances creditors with security interest on items purchased from or financed by them (such as furniture or jewelry) will not attempt to enforce the lien by taking the property.  

Also, liens on household goods not purchased from or financed by the creditor cannot be enforced. For instance, a security interest on household furniture given by a Debtor who borrows from a small loan company is not enforceable unless the purpose of the loan was for the purpose of purchasing the furniture.

Reaffirmation of real estate debts

Reaffirmation is not required for debts secured by real estate (land and buildings). As a matter of fact, it is a matter of federal law that filing for bankruptcy protection is not a violation of the mortgage contract. 

How to decide whether to reaffirm debts

Now to the question of whether or not to reaffirm. As to personal property, it is best to avoid reaffirmation because of the risk of post-bankruptcy default.  However, the Debtor who needs his or her automobile has little choice but to reaffirm.    

With real estate, the Debtor’s home, the answer is almost invariably no.  Reaffirmation is not required as to real estate.  The Debtor can retain the property and make the payments.  

The reason for not reaffirming is that mortgage liens on real estate are usually large, and with an uncertain job and real estate market, can expose the Debtor to the risk of default post-bankruptcy.  If the debt has been reaffirmed, the Debtor risks facing a foreclosure deficiency.  

In other words, the Debtor will go right back in to debt. 

Reaffirmation options in Chapter 7 bankruptcy cases

The Chapter 7 debtor has three options:  (1) surrender (give up) the financed property and discharge the debt; or (2) sign a new contract in the bankruptcy case (called a reaffirmation agreement), agreeing to continue making payments to the creditor who has the lien against the property, in exchange for keeping the property;  or (3) redeem the property. Redemption means paying the actual value of the property to the creditor. 

[help] To give an example of redemption, say the Debtor owes $10,000 on an automobile worth $5,000. The Debtor can redeem the automobile by paying the creditor $5,000. Unfortunately, the payment must be made up front, which means that redemption is not financially possible for many people who need bankruptcy protection.  

There are programs in which lenders will lend to redeem automobiles. These programs can be very useful when the Debtor’s automobile is worth considerably less than what is owed on it. Interestingly, these lenders also provide the financing to pay the legal cost associated with the redemption.[/help] 

Reaffirmation options in Chapter 13 bankruptcy cases

Chapter 13 Debtors have similar options:  (1) surrender the property and discharge the debt in accordance with the Chapter 13 payment plan (this creditor would be paid at the same rate as other unsecured creditors, such as credit card companies) or (2) keep the property and make the required payments as part of the Chapter 13 payment plan.  

In many if not most instances, the payment to the secured creditor will be made based on the value of the secured property and not the amount of the debt. This does not apply to the debtor’s principal residence. Generally, the interest rate paid on the secured portion of the debt will be greatly reduced.

Again, it should be underscored that reaffirmation agreements are neither required nor advisable for debts secured by real estate.

Deciding to reaffirm a debt or debts is a complex and often emotional decision. Be sure to consult an expert in bankruptcy law.