In Chapter 7 bankruptcy, if a debt is secured by property you want to keep (for example, your car), one way to keep the property is to reaffirm the debt. (To learn more about secured debts in Chapter 7 bankruptcy, and your other options for keeping the property, see our Secured Debt & Property in Chapter 7 area.)
Generally you can only reaffirm debt if your equity in the collateral (the property securing the debt) is exempt. If it’s not exempt, the trustee will likely want to sell the property to pay your unsecured creditors. (For more information, see Secured Property in Chapter 7 Bankruptcy: An Overview.)
What is Reaffirmation?
When you reaffirm a debt, you agree that you will still owe the debt after your bankruptcy case is over. Both the creditor’s lien on the collateral and your personal liability for the debt under the original promissory note survive bankruptcy intact—often, just as if you never filed for bankruptcy.
For example, if you owe $25,000 on your car before you file for Chapter 7 bankruptcy, you most likely will continue to owe $25,000 on your car after you file for bankruptcy (unless you negotiate a lower amount in your reaffirmation agreement). If you can’t keep up your payments and the car is repossessed, you’ll owe the difference between the amount you reaffirm for and the amount the lender is able to sell the car for at auction (considerably less than you owe, in most cases). This is called a “deficiency balance.” Nearly all states permit a creditor to sue for a deficiency balance for most types of property. About half of the states, however, don’t allow deficiency balances on repossessed personal property if the original purchase price was less than a few thousand dollars.
Advantages to Reaffirmation
Reaffirmation provides a sure way to keep collateral as long as you abide by the terms of the reaffirmation agreement and keep up your payments. Reaffirmation also provides a setting in which you may be able to negotiate new terms to reduce your payments, your interest rate, and/or the total amount you will have to pay over time.
Disadvantages to Reaffirmation
Because reaffirmation leaves you personally liable for the debt, you can’t walk away from the debt after bankruptcy. You’ll still be legally bound to pay the deficiency balance even if the property is damaged or destroyed. And because you have to wait eight years before filing another Chapter 7 bankruptcy case, you’ll be stuck with that debt for a long time.
For example, if you reaffirm your car note and then default on your payments after bankruptcy, the creditor can (and probably will) repossess the car, auction it off, and bill you for the difference between what you owe and what was received in the auction.
Example: Tasha owns a computer worth $900. She owes $1,500 on it. She reaffirms the debt for the full $1,500. Two months after bankruptcy, she spills a soft drink into the disk drive and the computer is ruined. Although she has lost the computer, because she reaffirmed the debt, she still has to pay the creditor $1,500.
Restrictions on Reaffirmation
Reaffirmation can be used with any kind of property and any kind of lien, but the creditor must agree to the terms of the reaffirmation if they are different from the current agreement.
You or the lender must file the agreement in court as part of your bankruptcy case. Unless an attorney is representing you in the bankruptcy or in the reaffirmation process, the bankruptcy court must review the agreement in a reaffirmation or discharge hearing. At that hearing, the judge will review your bankruptcy paperwork to see how the reaffirmation might affect your post-bankruptcy budget and whether you can afford the payments. The judge can disapprove the agreement if it is not in your best interest or would create an undue hardship for you. The judge is likely to reject the agreement if it looks like you won’t be able to make the payments after paying your basic living expenses or if you owe much more on the debt than the property is worth.
When to Use Reaffirmation
Because reaffirmation comes with the very serious disadvantage of leaving you in debt after your bankruptcy case is over, you should consider it only if:
- the creditor insists on it
- it’s the only way to hang on to collateral that you really need to keep, and
- you have good reason to believe you’ll be able to pay off the balance.
Reaffirmation may be the only practical way to keep some types of property, such as automobiles or your home. Also, reaffirmation can be a sensible way to keep property that is worth significantly more than what you owe on it.
If you decide to reaffirm, try to get the creditor to accept less than you owe as full payment of the debt. Don’t reaffirm a debt for more than what it would cost you to replace the property.
Keep Current on Payments if You Wish to Reaffirm
If you need to reaffirm a debt in order to keep the collateral, make sure you keep up your payments prior to filing for bankruptcy so you can stay on the creditor’s good side. If you fall behind, the creditor has the right to demand that you make your account current before agreeing to a reaffirmation contract, but you will probably have some room to negotiate. If the creditor rejects your payments during bankruptcy (which often happens), deposit that money into a separate account so it’s available once the creditor decides to accept it. If you can’t make these rejected payments when the creditor wants them, you might lose your property.