One of my jobs as your bankruptcy attorney is to help you prepare for life after bankruptcy – including rebuilding your credit while minimizing your potential risks. Today, I’d like to discuss reaffirmation strategies – and specifically – whether you should sign a reaffirmation agreement for a second or third mortgage.
But first, let’s back up and explain what a reaffirmation agreement is and why you might need one.
A common misconception I have encountered among my clients is that secured debts are non-dischargeable. This is not true. Your secured debts (e.g. mortgages and auto loans) are every bit as dischargeable as a credit card, payday loan, civil judgment, or medical bill. And that’s a good thing. This allows people to file for bankruptcy and walk away from their home and car free-and-clear – so they can get a true fresh start.
However, bankruptcy only discharges debt. It doesn’t get rid of the liens. So, if you file for bankruptcy and stop making payments on your mortgage – the lender may not be able to sue you for payment, but they can take back possession of their collateral (i.e. foreclosure).
Not everyone wants to surrender their home or car when they file bankruptcy. In fact, I’d estimate my clients choose to retain between 85% and 90% of their secured loans. So what do they do if their secured debt is dischargeable but they want to keep the collateral? Well, that’s where reaffirmation agreements come in.
Plainly-speaking, a reaffirmation agreement is the voluntary exemption of a debt from discharge. (Another way I like to think of it is that they turn a pre-filing debt into a post-filing debt.) Reaffirmation agreements are great in that they let you keep your stuff and help rebuild your credit faster. The downside to a reaffirmation agreement is that if you run into financial trouble again after your bankruptcy, the discharge won’t protect you from collection on that debt.
There are a number of things a bankruptcy client should consider before signing a reaffirmation agreement. I won’t get into those here. Suffice it to say, I include a comprehensive list of considerations as a cover letter when I send out reaffirmation agreements for the client to review.
What I want to discuss is a strategy in dealing with junior mortgages. IMPORTANT: This advice should not be followed blindly. There are a number of considerations that could affect your decision to sign an agreement or not, and you should discuss those particular circumstances with your bankruptcy attorney.
What I have found to be the best strategy in about 95% of cases is for the debtor to sign the reaffirmation agreement on the first mortgage, but not on any secondary mortgages (or HELOCs).
Why? Let’s pretend you file bankruptcy, sign the reaffirmation agreement on the first mortgage (let’s say Bank of America), don’t sign a reaffirmation agreement on the second mortgage (let’s say Associated Bank), and later hit another financial snag and default on your mortgage payments. The house is going into foreclosure and you’ve elected to walk away from it, but you’re hoping to not have to file bankruptcy again.
In the state of Wisconsin, primary mortgage lenders almost always waive seeking a judgment for a deficiency balance (the difference between what you owe on the mortgage and what the house sells for). Even though you signed a reaffirmation agreement with Bank of America, they’re not pursuing you for the money.
Associated Bank, on the other hand, is not required to waive deficiency. Because you didn’t sign a reaffirmation agreement, the bankruptcy discharge still protects you from collection attempts on this mortgage.
You might be asking yourself: Wouldn’t Associated Bank foreclose if I don’t sign a reaffirmation agreement? Highly unlikely. First, a junior lienholder will almost never foreclose (even in the event of a default), because at auction, the house will sell for less than what is owed on the first mortgage, which means the junior lienholder will have paid all of the expenses of a foreclosure and get nothing out of it in return. Second, most lenders won’t foreclose simply because you didn’t sign a reaffirmation agreement (it’s possible, but rare).
If you continue to make monthly payments to the creditor without signing a reaffirmation agreement, this is called a “ride-through”, and often considered a safe way to reaffirm while insulating yourself from liability down the road. The only real drawback to a ride-through is that many lenders will refuse to report payments to the credit bureaus in this instance. (If lenders report to credit bureaus, they are required to report accurately. However, they have no affirmative duty to report at all.)