Are Reaffirmation Agreements In Bankruptcy A Good Idea?
When you file a bankruptcy, you get to discharge most, if not all, of your debt obligations. This gives the consumer a fresh start going forward. The problem is that some of your assets may be secured. When consumers take out a loan to finance the purchase of a consumer good such as a car or tools, they give the person/business that gave a loan the right to repossess the item in case the debt can’t be paid.
The right to repossess the item is a security interest. This means that discharging the debt doesn’t completely solve your problem if you really want to keep the secured item. Bankruptcy releases the debt but not the security interest in the debt. The creditor, for example, can still repossess your car.
One way to handle the problem is to go through a Chapter 13 bankruptcy. Consumers use Chapter 13 to pay out their debts over a three to five year period. This lets the debtor keep any secured items include a car and even a house.
But Chapter 13 isn’t right for everyone. Some people have too many debts to be able to pay them in a five year or less time frame. Other people may just want to get rid of all their debts but save just one item like their car.
A second way to handle the problem is to file a Chapter 7 bankruptcy where all your other non-secured debts are discharged but you agree to pay for the secured item. The way this is done is through what’s called a reaffirmation agreement.
What Does Reaffirmation Mean?
Essentially, it means that the person who files for bankruptcy agrees to pay the debt after the bankruptcy case is done. The security interest (or lien of the creditor) on the property stays on the property and your obligation to pay the debt also stays – as if the bankruptcy hadn’t been filed. The secured debt can be a home, a car, tools or other items like a refrigerator.
- In order to reaffirm the debt, you have to have an equitable interest in the secured item. This means that you do the following:
- You figure out the value of the item. For a car, there are guide books that say what the value is for every brand and year of vehicle. For other items, an expert may be needed to value the property. For example, someone who is an expert in construction appraisals will be used to value certain work tools
- You figure out how much you still owe to pay off the debt
- You subtract the second item (the amount you owe) from the first item (the value of the car). If the subtraction leaves a positive figure, then you have equity. If the subtraction leaves a negative figure, then you don’t have equity.
For example, if you have a car worth $10,000 and you owe $$7,500, then you have equity in the car in the amount of $2,500. If you owed $15,000, then you wouldn’t have any equity in the car.
As a practical matter, there’s no logic in continuing to pay for something that you don’t have an equity in. In the example, if the car is worth $10,000 and you owe $15,000, it makes more sense to start over and buy a new $10,000 car where you’ll only owe $10,000.
- You then need to see if your equity in the secured property is protected through your exemptions. Federal bankruptcy law allows for a variety of exemptions so the debtor isn’t stripped of everything (note Connecticut has it’s own specific set of exemption laws). One of the exemptions is $3,675 for your motor vehicle There are overall exemptions that can also help that your lawyer will explain. As long as your item is protected by an exemption, the debtor can then think about possibly reaffirming the debt and keeping the secured item.For example, if your equity in the car is $2,500, then your exemptions will let you reaffirm the debt. But if the car is really worth $75,000 and you only owe $5,000, then you won’t be able to keep the car. Instead, the trustee will sell it. You will get your exempt amount and the rest will be used to pay creditors.
What are the Pros to Reaffirmation?
The main advantage is that you get to keep a valuable asset. Buying a new asset on credit (even for the same loan amount) may be hard because bankruptcy does affect your ability to get credit. Additionally, when you reaffirm the debt, you may be able to renegotiate the amount of the loan. It’s a lot of work to repossess and resell a car. Your Connecticut bankruptcy lawyer will use that work hassle to get you better terms such as more time to pay, a lower interest rate or even a lower overall amount that will be due.
What are the Cons to Reaffirmation?
If you agree to repay the loan, then you can’t use bankruptcy protection for another 8 years. In short, you will be stuck with the loan for a long time. If you can’t pay the debt, your car will be repossessed and sold. The creditor may come after you for a deficiency judgment (the amount of the loan plus the cost to sell it minus the value of the car).
To renegotiate the loan, you need the approval of the creditor. If you agree to pay the same loan terms, you don’t need the creditor’s approval. As mentioned, the creditor does have some incentive to renegotiate if it means a better chance of getting his/her money.
Reaffirmation Requirements
The reaffirmation agreement is a formal agreement. There is hearing to determine if you can really pay off the secured debt. The bankruptcy judge may not approve the agreement if he/she thinks it’s not in your best interest or that it will be a hardship for you. It’s best to have an attorney represent you to make sure the agreement is properly prepared, the terms are renegotiated to your advantage and to review whether you can really pay the debt.
The bigger the amount of the debt, such as for a mortgage, the more likely it is the judge may disapprove the reaffirmation agreement.
You should keep current on your payments while the case proceeds through bankruptcy or be ready to pay the arrears before the reaffirmation agreement is signed.
