Most people know that Chapter 7 bankruptcy is primarily used to wipe out, or discharge, unsecured debts like credit card, medical bills and personal loans of all types. But what about secured debts – your house, car, furniture, jewelry? What happens to those loans when you file Chapter 7?
Mortgage loans, car loans, jewelry loans and most furniture loans are called secured debt because the property you buy functions as security for the loan. Thus, if you do not pay your car loan, the car finance company can repossess its collateral (your car) without first having to file suit against you in court. By contrast, an unsecured creditor like a credit card company cannot repossess anything – they have to file suit against you, obtain a judgment, then they can only execute their judgment against certain assets – usually your wages or bank accounts.
When you file Chapter 7, you have to make a decision about what you want to do about your secured debt. You cannot keep the secured property and not pay for it. Here are your options:
Stop paying and surrender the collateral – if you cannot afford to pay for your secured debt, you can simply surrender it back to the creditor and be free of any further claims. When you surrender in Chapter 7 there will be no deficiency claims or other recourse if you surrender the property.
Redeem the secured property by paying the secured creditor its fair market value – redemption is a relatively uncommon resolution because most people filing bankruptcy do not have access to a lot of cash. However, if you have a generous relative, you may be able to work out a very favorable deal redeeming your secured collateral for its value, rather than the remaining contract balance on your loan.
Reaffirm the secured debt – reaffirmation is a fairly common way to deal with secured debt. When you reaffirm a debt, you agree to revive your prior installment agreement. This means that you will again be personally responsible for paying this debt. If you reaffirm and later on default, you can be held personally liable, meaning that you would potentially be at risk for a deficiency claim, and wage garnishment.
- You can only reaffirm if your budget shows that you have sufficient disposable income to afford the debt you are reaffirming. If, for example, you are unemployed and you file Chapter 7, you are not going to be able to reaffirm your car note if you cannot show the court that you have the funds to pay that note in the future.
- Reaffirmation agreements consist of about 10 pages of disclosures and budget calculations. Your lawyer has to sign off on the reaffirmation agreement and certify that we believe you have the financial resources to afford the reaffirmed debt.
- Another issue with reaffirmations – once the reaffirmation paperwork is completed by you and your lawyer and returned to the lender, the lender has to file this agreement with the Bankruptcy Court. We have seen a number of cases where the lender did not file the returned reaffirmation agreement and it did not become part of the record. Thus, it is a good idea to start the reaffirmation process early You have no recourse if your lender does not cooperate.
Keep and Pay – many lawyers strongly advise against entering into a reaffirmation agreement. Instead, they recommend that you “keep and pay” your collateral. In other words, you would not enter into a formal reaffirmation agreement – instead you would just continue making payments as if you had never filed bankruptcy.
The advantage to this approach is your avoidance of personal liability for a possible future default. In other words, if you keep and pay on a car note, you could decide in a year that you want to give up the car because it has become too expensive to fix and you simply turn it in, return the keys and walk away. Similarly you can keep and pay your house and if you later decide that you want to move you can simply walk away without worrying about any deficiency claims.
Our experience has been that lenders usually would rather have your money than their collateral so keep and pay is a popular option and it usually works. There are, however, a few downsides to keep and pay:
- the lender does not have to participate. Since there is no contract with a specified default provision, you have very little legal protection if your creditor decides to take back its collateral
- your credit report will not reflect your payments. Since your Chapter discharge will wipe out your personal responsibility for the secured debt, your credit report will not show any positive ratings for on-going payments that you might make in years to come. This absence of “positive credit” may hinder your ability to obtain a mortgage in the future
- we receive numerous questions and comments on our blog from Chapter 7 debtors who did not reaffirm their mortgages, and who are now having trouble obtaining a refinance or qualifying for a new mortgage loan.
Most of the time, our clients either choose to reaffirm, or they go the “keep and pay” route and usually have little problem. You do, however, have to decide what you want to do while your case is active. If you decide not to reaffirm, and then 2 years later you decided that you have changed your mind, you are most likely not going to be able to reopen your Chapter 7 case solely to reaffirm.