There’s no one size fits all answer, but the general rule when it comes to reaffirming mortgage debt in bankruptcy is “don’t.” Reaffirming mortgage debt is great for the lender. For the bankruptcy petitioner though, reaffirmation of mortgage debt generally leads to increased future risk and increased attorney fees. In other words, there’s little or no upside for most homeowners.
Reaffirming can be especially risky when the mortgage is “under water,” meaning that the homeowner owes more than the house is worth. That’s because if the homeowner ultimately loses the house, they can be on the hook for the difference. In 2022, two of the five zip codes with the highest percentages of underwater mortgages in the country are in Ohio. Even in 2021, when the housing market was booming, Dayton, Akron and Cleveland were all on the top 10 list for underwater mortgages.
What is a Reaffirmation Agreement?
When you reaffirm a debt in bankruptcy, you waive the protection you would otherwise receive through the bankruptcy discharge, and agree to remain personally liable for the debt. Many people who want to keep their homes or other property that serves as collateral for a debt don’t see a problem with reaffirming. After all, they are planning to continue to make payments. So, it seems like it won’t make much difference if they’re legally required to do so.
However, life doesn’t always go as planned.
The Number One Risk of Reaffirmation
When debt is discharged in bankruptcy, the bankruptcy petitioner is no longer personally responsible for that debt. Therefore, if a homeowner files bankruptcy, does not reaffirm the debt, and receives the discharge, he or she is no longer liable for the outstanding balance and the mortgage. Of course, a homeowner who wants to keep the property must continue making payments–the lender can still foreclose on the property if the homeowner defaults or stops making payments. However, foreclosure will be the mortgage holder’s only remedy.
On the other hand, if mortgage debt has been reaffirmed, the homeowner remains personally liable for the debt. In that situation, if the borrower falls behind on debt payments, the mortgage holder may foreclose as in the reaffirmation example above. However, with the reaffirmation, the mortgage lender can also personally pursue the borrower for any remaining balance.
Here’s how that plays out for real people in bankruptcy:
Imagine that Debbie and John each file bankruptcy. Each owns a home in Dayton, Ohio worth $150,000, and is carrying $170,000 in mortgage debt. In other words, Debbie and John are each $20,000 “underwater” on their mortgage debts.
In bankruptcy, Debbie reaffirms her mortgage debt. John does not.
Several months after bankruptcy discharge, each falls on hard times, and becomes unable to keep up mortgage payments. Both mortgage lenders foreclose, and both homes sell at auction for $40,000 less than the outstanding mortgage balance.
Debbie’s and John’s circumstances are identical, except that Debbie reaffirmed and John did not. John loses his home, but because his mortgage debt was discharged in bankruptcy, is not personally liable for the deficiency balance. The mortgage holder receives the proceeds of the sale, and that is the end of the road.
Debbie also loses her home. However, because she reaffirmed, her story doesn’t end there. Debbie is still personally liable for the loan. That means the mortgage lender can continue to pursue collection action against her, even sue her for the deficiency balance. Since it has only been a matter of months since Debbie received her bankruptcy discharge, it will be years before she can file another Chapter 7 case and discharge the remaining mortgage debt. In the interim, she may face aggressive collection actions , wage garnishment, and even seizure of property or bank accounts.
In short, the decision to reaffirm may have cost Debbie tens of thousands of dollars, and years of additional financial stress.
What is the Upside to Reaffirming Mortgage Debt?
While some bankruptcy petitioners who own their homes want to reaffirm mortgage debt, the benefits are fairly limited. For example, if a bankruptcy petitioner keeps the house and continues to make payments without reaffirming, mortgage lenders typically will not report those payments to the three major credit reporting agencies. Therefore, the bankruptcy petitioner loses the value of those on time payments as a tool for rebuilding credit after bankruptcy.
There may be other minor inconveniences associated with not reaffirming. For example, some mortgage lenders will stop sending monthly statements. That means the borrower must take responsibility for ensuring that appropriate payments are made in a timely manner without a reminder.
However, it is difficult to see how these minor benefits could be worth the risk associated with continuing personal liability.
The Cost of Reaffirmation
Many bankruptcy clients question the additional attorney fees associated with a mortgage reaffirmation. Of course, the main reason that we discourage most clients from entering into a mortgage reaffirmation agreement is that it puts the benefits of the bankruptcy at unnecessary risk for very little return. When the bankruptcy filer is adamant about pursuing reaffirmation, however, that service is not included in our standard bankruptcy flat fee. That’s because a mortgage reaffirmation requires considerable additional work on the part of a bankruptcy attorney.
It is often difficult to get the lender to execute a reaffirmation agreement. In addition, bankruptcy law requires the attorney to make a determination as to whether or not the debtor can afford to reaffirm. If the bankruptcy lawyer takes responsibility for assuring the court that he or she has determined in good faith that the debtor can afford to reaffirm, the court will typically approve the reaffirmation agreement without hearing. However, it is rarely in the debtor’s best interest to reaffirm mortgage debt. And, if the attorney opts not to sign off on reaffirmation, then a hearing before the bankruptcy court is required.
The bottom line is that we generally discourage reaffirmation of mortgage debt. Any bankruptcy petitioner who chooses to move forward with reaffirmation must carefully weigh the increased risk of significant future liability and the increased time and expense in the bankruptcy process.