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Secured Debts in Chapter Seven Bankruptcy: To Reaffirm or Not to Reaffirm

May, 2011

Chapter Seven bankruptcy is designed to assist debtors in financial difficulty who do not have the ability to pay their existing debts. In exchange for having their debts “discharged,” however, a Chapter Seven debtor may have to give up certain property, which is then auctioned off, with the proceeds applied towards their debt.

Fortunately, bankruptcy laws often allow a debtor to protect or “exempt” some, if not all, of their property. But despite those protections, any property that a debtor previously used as collateral to secure a debt (such as a mortgage or auto loan) will usually continue to have an enforceable lien applied against it. This means that the secured creditor may have the right to seize and auction off the property and apply the proceeds towards the secured debt. (Note: The debtor is not legally responsible for any remaining balance owed.)

If a debtor wishes to keep property that they have used as collateral, however, the debtor can opt to “reaffirm” the underlying debt. A reaffirmation is an agreement between the debtor and the creditor that the debtor will remain liable and will pay all or a portion of the debt, even though the debt could otherwise have been discharged through the bankruptcy. The creditor, in turn, promises not to seize the property so long as the debtor continues to pay the debt. (If a debtor decides to reaffirm a debt, he or she must sign a written reaffirmation agreement and file it with the court before a final discharge order is entered.)

Given the considerable protections offered by reaffirmation of a debt, Chapter Seven bankruptcy debtors with secured debts must answer an important question – to reaffirm or not to reaffirm their secured debt. The best course of action for any debtor in this position is to make this decision after consultation with a bankruptcy lawyer, but here are some important factors to consider in the meantime:

If You Reaffirm the Debt…

  • You will continue to have the legal right to keep the collateral, as long as you continue to make your loan payments in a timely manner.
  • Despite eventually receiving your bankruptcy discharge, you will continue to have the legal obligation to pay the loan. This means that if you eventually default and the collateral is seized, you could be sued for any remaining balance owed.
  • Your credit score will continue to be affected by the loan. Each time you make a payment on time, your score will improve. Each time you miss or are late with a payment, your score will suffer.
  • If the creditor previously sent you monthly billing statements, they will likely continue to do so.
  • If the creditor previously allowed you to make payments online or by phone, they will likely continue to do so.

If You Do Not Reaffirm the Debt…
  • You no longer have a legal obligation to pay the secured loan.
  • You no longer have the legal right to keep the collateral.
  • The creditor may be able to seize and auction-off the collateral to try to satisfy their debt. However, you are not legally responsible for any remaining balance.
  • Despite not reaffirming the debt, you can still contact the creditor and try to negotiate a settlement. In fact, often times a creditor will allow you to retain the collateral as long as you continue making “voluntary” payments in accordance with the terms of your original agreement.
  • You can still contact the creditor to request monthly statements and the ability to make voluntary payments online or by phone.
  • If you reach an informal settlement with the creditor, your future “voluntary” payments (or lack thereof) will not affect your credit score. Instead, your credit reports will simply state that your legal obligation to pay the debt was discharged through bankruptcy.

Another, less common option for keeping collateral through Chapter Seven bankruptcy involves “redeeming” the underlying secured debt. This basically requires the debtor to pay a lump sum upfront to the creditor in an amount equal to the current fair market value of the collateral. Unfortunately, however, when it comes to an automobile or a home, most debtors cannot afford this option, leaving them with the critical decision whether to reaffirm. 

Willig, Williams & Davidson’s bankruptcy attorneys are well-equipped to assist debtors in navigating the complex rules governing Chapter Seven bankruptcy, including issues related to reaffirmation of secured debt. We are defined by the Bankruptcy Code as a “debt relief agency,” because we help people file for bankruptcy relief under the Bankruptcy Code.

For more information about reaffirmation of secured debt or other bankruptcy issues, contact Willig, Williams & Davidson and ask to speak with one of our bankruptcy attorneys.

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