Should I Reaffirm My Mortgage in a Chapter 7 Bankruptcy?

I get asked this question frequently. The short answer in California is “no,” but there are rare exceptions. To understand those exceptions, we need to know something about the nature of reaffirmations.

What is a Reaffirmation?

In the normal Chapter 7 case, a few months after the bankruptcy is filed all dischargeable debt is discharged. To “discharge” a debt means that there is a legal bar to the creditor attempting to collect on the debt.

While the debt owed to your mortgage company is discharged in Chapter 7, their mortgage on your property is not discharged. Mortgage companies will sometimes send "Reaffirmation Agreements" to debtors in Chapter 7 proceedings. This will reinstate your mortgage debt as if it were never discharged in bankruptcy.

Normally, a debtor would only reaffirm a debt if there was a significant benefit to doing so. For example, if a car lender is allowed to repossess a car under bankruptcy and state law if a debt is not reaffirmed, that might be a good reason to reaffirm the debt and the court will often approve this kind of reaffirmation.

What I encourage clients to do is to examine the benefits and drawbacks to doing a reaffirmation agreement. Most of the time, the drawbacks far outweigh the benefits of a mortgage reaffirmation. Following is a list of potential benefits and drawbacks:

Benefits of a Mortgage Reaffirmation

  • Avoiding Possible Foreclosure. If the lender could foreclose on a house unless a reaffirmation was signed, that might be a good reason. However, the lender cannot foreclose on a house due to a failure to sign a reaffirmation agreement under California and bankruptcy law. So this is almost alwasy not a reason to do a reaffirmation on a mortgage.
  • Credit Reporting. One reason that mortgage companies suggest for debtors signing reaffirmation agreements is that it will look better on a debtor’s credit report. However, that is not a quantifiable benefit that a court would consider in determining whether to approve the reaffirmation and is far outweighed by the problems listed below.
  • Loan Modification. Sometimes, mortgage lenders will offer significantly better mortgage terms to entice a debtor to agree to a loan modification. Such better loan terms might outweigh the drawbacks listed below and give good cause for the reaffirmation. For example, if the lender reduced the principal balance to the current market value of the property, lowered the interest rate and lowered the payment by extending the loan, that might be a good reason for the debtor to sign a reaffirmation agreement. However, such offers from mortgage companies are rare. And usually a reaffirmation needs to be done within about 75 days from the date of filing. Mortgage servicers are usually so slow about offering loan modifications that they would never be able to meet this time frame.

Drawbacks of a Mortgage Reaffirmation

  • Continuing Deficiency Liability on the Junior Mortgage. This is the biggest issue with signing a mortgage reaffirmation. If a debtor signs a reaffirmation agreement on a junior mortgage and the senior mortgage forecloses at some point in the future, the junior mortgage will likely be able to collect against the debtor. Because the amount of some junior mortgages are quite large (junior mortgages over $100,000 are not uncommon), this could present a huge problem for the debtor, especially since the debtor has already filed a Chapter 7 bankruptcy and cannot file another for 8 years.
  • Continuing Deficiency Liability on the Senior Mortgage. This is also a problem, although not as significant as the junior mortgage issue. The reason it is not as significant is that almost all foreclosures in California are non-judicial foreclosures. With a non-judicial foreclosure, the lender has a “one-action” rule which requires the lender to give up any deficiency after the property is sold at the trustee’s sale. However, if a lender were to do a judicial foreclosure, there might be deficiency liability. Because of this potential liability and how large the liability could be, this normally weighs against debtors signing a reaffirmation on a senior mortgage.
  • Difficulty in Obtaining Judicial Approval. This is a significant problem. Because there is usually no good reason to sign a reaffirmation agreement on a mortgage, lenders will normally not approve such agreements. If the court will not approve the agreement, going through all of the work to prepare the agreement and submit it to the court is usually not a good idea. The exception to this is if a loan modification (as discussed above) is offered. In that case, the likelihood of obtaining court approval would be much higher.

For all of these reasons, debtors in California should almost never sign a reaffirmation agreement on a mortgage, with the only exception being if a substantial loan modification was offered as part of a reaffirmation agreement.