At the end of the last blog, Can i keep my house or car if i file a Roseville MN Bankruptcy, I wrote that even if a client of mine owned a vehicle that he or she liked, with a payment that the client could afford and the car was a new enough model that it was possible that the lender would repossess the car unless the client signed a reaffirmation agreement, I would still advise the client not to do so. Why? In my analysis, it all comes down to worst-case scenarios. By definition, with my bankruptcy practice I am not dealing with lucky people. My clients are my clients because things have not worked out as planned for them financially, or some sudden unanticipated event has taken place to create financial strain. My clients at our Bankruptcy Law Firm in Roseville are used to having worst-case scenarios come true.
Whats The Worst That Can Happen?
So what is the worst case scenario with respect to a car loan?The obvious answer is that something happens where the client can no longer afford to make the car payment. In that event, the car lender is going to repossess the vehicle once the loan goes into default. And the vehicle is going to be repossessed whether or not the client has signed a reaffirmation agreement. If the client has signed a reaffirmation agreement, the client will be legally responsible for the deficiency between the loan balance as of the time the car was repossessed, together with the costs of repossession (tow-truck, storage, etc.) and the sales price of the vehicle when the vehicle is sold at an auction. Since my clients buy their vehicles at a retail car dealership, and the car is purchased at auction for (usually) less than wholesale value, there is almost always a deficiency following the auction sale.
But there’s another, more subtle variation of this worst-case scenario. In this scenario the client can still afford to make the car payment, but unfortunately the car has mechanical issues or body damage, and the cost of repair is greater than the value of the vehicle, or the cost of repair is unaffordable for the client. In this case, the problem is the same as the first, most obvious “worst-case” - the vehicle has simply become too expensive. And if the client has signed a reaffirmation agreement, the client has to continue making the payments on the loan for the car that is too expensive to pay for. For either of these two scenarios, the client has to continue to pay for a car he or she can no longer drive. In all likelihood the client will have to replace the car that has been repossessed or that can’t be driven, usually by taking out a loan to purchase another car and continue to pay for the car that the reaffirmation agreement covered.
As human beings, we want the money we spend to bring us value in return. Paying for a car that can’t be driven is the opposite of receiving value for the money we’re spending. That’s the problem with signing reaffirmation agreements: there’s a possibility that by doing so, clients will be creating extremely expensive obligations for something that almost every adult needs: a functional car.
Have Car Repossessed Or Reaffirm Car Loan After Bankruptcy?
Think about the worst-case scenario for the client who chooses not to sign a reaffirmation agreement. The worst case for the non-signer is that the lender will repossess the car. That certainly is not something anyone would like to have happen. If there is a repossession, then the client has to replace a car. There’s the likelihood of another car payment, and since the client has filed a bankruptcy case, the car will probably not be a newer model, and the interest rate for the car loan is going to be higher than one would like. But that person - the client who does not sign a reaffirmation agreement - only has one car payment. That’s the difference in the worst-case scenarios. The scenario in which there is no reaffirmation agreement ends with a client having one, not two car payments. The non-signing scenario is less expensive. So even if the car loan is affordable, and even if the car is a model that has an enhanced likelihood of being repossessed, my advice to clients is don’t sign reaffirmation agreements for car loans.
Should I Reaffirm My Mortgage Debt After Bankruptcy?
That’s the story with car loans. Home mortgage lenders will sometimes, although not all the time, also send you reaffirmation agreements. In an earlier blog I discussed the pros and cons of signing reaffirmation agreements for first mortgages. Since Minnesota is a “no-recourse” state, mortgage lenders generally do not have the ability to collect a deficiency following a first mortgage foreclosure. So the risk in signing a car loan reaffirmation agreement really isn’t present with first mortgage reaffirmation agreements. If a clients signs a first mortgage reaffirmation agreement and later defaults on the mortgage loan, the lender will still foreclose, but assuming that the lender forecloses by advertisement (and almost all mortgages are foreclosed this way in Minnesota), the debtor need not worry about having to pay a deficiency if the home sells for less than the mortgage balance.
And since filing a bankruptcy case, or filing to sign a reaffirmation agreement following the filing of a bankruptcy case is not grounds for a mortgage lender to start a foreclosure, the non-signing client really doesn’t face the same risks that a non-signing client does with a car loan. The mortgage company can only foreclose if there is a default in payments, a failure to pay property taxes, a failure to maintain insurance, or if the borrower/debtor is damaging the property intentionally or recklessly. The stakes are lower.Remember, though, that this just applies to first mortgages. I will discuss second mortgage loans later - and that is a much different situation.
Here is the dilemma facing homeowners with respect to first mortgage loans: some lenders (not all) will report the mortgage loan as being “in bankruptcy” even if the borrowers have been making timely monthly payments on their mortgage, and even after the bankruptcy case has been discharged. Some mortgage companies will not note that the mortgage has been paid in a timely way, even though that’s the case. This report (and the lack of noting timely payments) can create problems for borrowers/debtors who are seeking to refinance their mortgage loan - particularly if the borrower is seeking to refinance through the same mortgage carrier as had the mortgage at the time the bankruptcy case was filed. On the other hand, if there is a reaffirmation agreement signed by the debtors and approved by the Bankruptcy Court, and the borrower/debtor makes timely payment, the loan will be reported to be in good standing.
Thus my Roseville Bankruptcy Attorneys and I advise clients that signing reaffirmation agreements on first mortgage loans might be in their best interests. Just like with car loans, the debtor’s budget must show that the mortgage being reaffirmed is affordable for the debtor to pay - so a good look at the client’s budget is necessary. And, ironically enough, the lender must propose a reaffirmation agreement to the debtor. Unlike car loans, in which reaffirmation agreements are offered without fail, some lenders don’t propose reaffirmation agreements. And unfortunately some of the lenders will use the failure to sign a reaffirmation agreement as a grounds to deny refinancing an existing mortgage loan - even though the lender did not propose a reaffirmation agreement for the debtor’s consideration.
So if a client believes the mortgage reaffirmation is affordable, I generally do not object to my clients signing. But what to do if there was no reaffirmation agreement signed, and a debtor would like to try to refinance? How does a debtor get around a credit report that says that the mortgage loan was included in a bankruptcy and does not report timely payments?
Rules For Refinancing After Bankruptcy
The first thing to do for a client who wishes to refinance a mortgage loan in this situation is to deal with another mortgage company, rather than the current lender. The client should request a payment history from the lender (the lender has to supply you with a history of your payments if asked). Armed with a payment history, the client can check with other lenders about refinancing the loan through a different mortgage carrier, with a relatively high likelihood of success.
A client can normally accomplish a refinance in this situation, although the client may have to tolerate some delays while obtaining a payment history and go through the borrowing process with a new lender.
But that is the story with first mortgages. What should a client do if a second mortgage company proposes a reaffirmation agreement on the second. In my opinion, the client should never sign a reaffirmation agreement for a “junior” mortgage - either a second mortgage or a home equity line of credit. Why not? Unlike first mortgages, second mortgages or home equity lines are recourse notes - that is, the lender can assess a deficiency against a borrower, and the second mortgage holder can sue the borrower on the note. Second mortgages have many more courses of action to collect on defaulted second mortgages than first mortgage companies.
Also, due to the great recession, there are still second mortgage loans that are under-collateralized. That is, the value of the home is less than the combined balances of a first a second mortgage. If a client in this situation defaults on the second mortgage loan, that mortgage lender does not have to start a foreclosure proceeding. The second mortgage holder can simply start a lawsuit against the borrower, with the idea that a judgment will be entered against the borrower and the second mortgage company can collect the money owed it without having to go through a foreclosure. This appeals to second mortgage holders since in order to foreclose, it must pay off the first mortgage on the property before it can foreclose its second mortgage. So foreclosing on a second mortgage can be quite expensive, depending on the balance owed on the first mortgage.
Because a second mortgage is a recourse note, it is important for bankruptcy debtors to discharge their personal liability on second mortgages. And because second mortgage holders may not want to pay off first mortgages in cases where the first mortgage is in default, second mortgage holders will often propose a reaffirmation agreement to bankruptcy debtors.
Bankruptcy debtors should not sign reaffirmation agreements on second mortgage loans. Clients should understand that second mortgage companies cannot foreclose on its mortgage simply because a bankruptcy debtor chooses not to sign a reaffirmation agreement. Just like a first mortgage, second mortgages can only be foreclosed if there is a default in payment. And clients should keep in mind that to foreclose on a second mortgage, the second mortgage holder must pay off the balance of the first mortgage - in most cases an expensive proposition. So clients are well advised to avoid reaffirming second mortgage loans.
Reaffirming Secured Debt In A Chapter 7 Bankruptcy
It is important to keep in mind that the discussion of reaffirmation agreements only applies to Chapter 7 bankruptcy cases. There are no reaffirmation agreements in Chapter 13 cases. Remember that one of the reasons for a person dealing with financial difficulty to consider a chapter 13 bankruptcy is to preserve assets - and this includes assets, such as home mortgages and car loans - that are collateral for loans. Another feature of chapter 13 is the ability, in some cases, of being able to “rewrite” car loans. This is available to chapter 13 bankruptcy debtors who are dealing with high interest car loans and/or loans that have been in existence for more than two and a half years. Chapter 13 provides a way for people in these situations to lower the interest rates on their car loans and in some cases to reduce the balance of a loan that is under-collateralized. So instead of struggling to decide whether to reaffirm a car loan in a chapter 7 case where the terms of the loan are not advantageous to a bankruptcy debtor, chapter 13 offers a way to make a car loan more affordable and remove the possibility of repossession.
The Bottom Line
The bottom line is that while it is understandable that people want to retain their homes and cars, bankruptcy debtors need to be smart about making the choice whether to reaffirm their liability on a loan and shouldn’t forget about the chapter 13 option if they want to retain collateral. To learn more or further information get in touch with me at:Kain & Scott, P.A.
100 South Fifth Street #1900
Minneapolis, MN 55402