Bankruptcy: What is a reaffirmation agreement?
Key takeaways
- A reaffirmation agreement allows you to retain a specific asset (commonly a house or car) during bankruptcy in exchange for agreeing to pay the outstanding debt.
- If you request a reaffirmation agreement, you must submit a statement of intent to the court and contact the lender to establish terms.
- Once reaffirmed, the debt is no longer discharged in bankruptcy, meaning the debtor is fully liable. If payments are not maintained, creditors can repossess the asset and seek repayment of the remaining balance.
Making a reaffirmation agreement can be helpful if you want to stay in your home or keep driving your car during a bankruptcy settlement. However, this type of agreement means you are still responsible for some payment on the loan. Make sure you understand precisely how it works and what you will be responsible for so you don’t owe payments you can’t make.
What is a reaffirmation agreement?
A reaffirmation agreement is a legally binding contract between a debtor and a creditor during a Chapter 7 bankruptcy proceeding. It allows the debtor to voluntarily commit to repaying a specific debt that would otherwise be discharged through the bankruptcy process.
This type of agreement is typically used for secured debts, such as car loans or home mortgages, where the debtor wishes to keep the collateral securing the loan. By signing the agreement, the debtor agrees to continue making payments under the original or modified loan terms, effectively removing that debt from the bankruptcy discharge.
Reaffirmation agreements require court approval to make sure the debtor can reasonably afford to continue making the payments. If the debtor has an attorney, the attorney must confirm that the agreement is in the debtor’s best interest and won’t cause undue financial hardship. If the debtor is unrepresented, the court takes a more active role in reviewing the agreement. The court may reject reaffirmation if it deems that the debtor cannot meet the repayment obligations without further financial strain.
Once a reaffirmation agreement is approved, the debt becomes an ongoing obligation. The debtor must continue making payments as agreed, and if they default, the creditor can take legal action, such as repossessing the collateral or suing for the remaining balance.
While reaffirming a debt can help debtors retain assets like cars or homes and may improve their credit after bankruptcy, it also carries significant risk, as they remain liable for the total amount of the reaffirmed debt.
Why would you want to reaffirm a debt?
A reaffirmation agreement can be a strategic decision for debtors going through Chapter 7 bankruptcy, particularly when they want to retain essential assets like a car or home.
One of the primary reasons for reaffirming a debt is the ability to keep the property tied to a secured loan. For example, if you have a car loan, reaffirming the debt allows you to continue making payments and avoid repossession. For many people, losing a vehicle can severely impact their ability to work and maintain their daily responsibilities, making reaffirmation a practical choice despite the ongoing financial obligation.
Another reason you might pursue a reaffirmation agreement is to help rebuild your credit after bankruptcy. While bankruptcy discharges most debts, it also significantly impacts credit scores. By reaffirming a loan and making consistent payments, you can show creditors you are responsible and capable of handling debt. This can help restore your financial standing, as regular payments on reaffirmed debt may be reported to credit bureaus, helping to improve credit over time.
In some cases, reaffirmation also provides an opportunity to renegotiate loan terms. Creditors may be willing to offer better conditions, such as lower interest rates or extended payment terms, as part of the reaffirmation agreement. This makes the debt more manageable while allowing you to keep the asset.
Additionally, reaffirming a debt can help preserve a positive relationship with the creditor, which might be helpful for future borrowing.
Pros and cons of reaffirmation
Reaffirmation can be helpful if you’re trying to keep important assets or rebuild credit after bankruptcy. However, it also carries significant risks, as it reestablishes liability for debts that could otherwise be discharged. Considering your financial situation and whether you can realistically afford to reaffirm the debt is essential.
Here are the pros and cons of reaffirming a debt during Chapter 7 bankruptcy.
Pros
- Ability to keep property: One of the most important benefits of reaffirming a debt is the ability to keep secured assets, such as a car or home. If you rely on your home or need your vehicle for work, reaffirming ensures you can continue using those assets while making regular payments.
- Rebuilding credit: Making payments on a reaffirmed debt can help you rebuild your credit after bankruptcy. Lenders report those payments to credit agencies, demonstrating your financial responsibility and gradually improving your credit score.
- Potential for better loan terms: Creditors might offer more favorable loan terms as part of the reaffirmation agreement. For example, you may be able to negotiate a lower interest rate, reduced monthly payments or an extended payment period, making the debt easier to manage.
- Preserving relationships with creditors: Reaffirming a debt can help maintain a positive relationship with your creditor. This could be beneficial if you wish to do business with the creditor again in the future, such as seeking another loan or mortgage after bankruptcy.
Cons
- Continued liability: Once you reaffirm a debt, you are legally obligated to continue making payments on it. If you fall behind, the creditor can pursue collection actions such as repossession or suing for the balance owed. Unlike other debts discharged in bankruptcy, a reaffirmed debt remains your responsibility.
- Court scrutiny: Reaffirmation agreements require court approval. If the court determines that the agreement is not in your best interest or will cause undue financial hardship, the reaffirmation may be denied.
- Financial risk: Reaffirming a debt can be risky if your financial situation is uncertain. If you’re unable to keep up with payments, you could lose the asset (e.g., through repossession) and still owe any remaining balance on the loan, putting you in a worse financial position.
- Impact on fresh start: Bankruptcy is designed to give individuals a financial “fresh start” by eliminating most of their debts. By reaffirming a debt, you’re choosing to retain some of the financial burdens and limit the financial relief you get from the bankruptcy process.
How to request a reaffirmation agreement
Requesting a reaffirmation agreement involves several steps that must be followed carefully, especially in a Chapter 7 bankruptcy. Here is a guide on how to request a reaffirmation agreement:
- Identify the debt you want to reaffirm: Determine which secured debt you wish to keep and reaffirm. Ensure that continuing payments on this debt fit within your post-bankruptcy financial plan.
- Contact your creditor: Contact your creditor and express your intention to reaffirm the debt. Discuss any terms or modifications (like lower interest rates) that might make the payments more manageable.
- Review and sign the agreement: Carefully review the terms once the creditor prepares the reaffirmation agreement. If you have an attorney, they will ensure the agreement is fair and that you can afford the payments. Sign the agreement if you agree to the terms.
- File the agreement with the bankruptcy court: After signing, the agreement must be filed with the court before your bankruptcy is discharged. If you have an attorney, they will handle this step. If you’re representing yourself, ensure that the agreement is submitted to the court for approval on time.
- Court approval and payment continuation: Sometimes, the court may schedule a hearing to ensure reaffirmation is in your best interest. Once the court approves the agreement, it becomes legally binding, and you must continue making payments as outlined in the agreement.
Having an attorney can make the process smoother. They can provide legal advice, ensure a fair agreement and represent you in court.
Alternatives to reaffirmation: In some cases, debtors may choose not to reaffirm but rather “redeem” the property by paying the creditor a lump sum to settle the debt. Another option is to “surrender” the asset if keeping it is not financially feasible.
Canceling a reaffirmation agreement
To cancel a reaffirmation agreement, you must act quickly. The law allows you to rescind the agreement before the bankruptcy discharge is issued or within 60 days after the reaffirmation agreement is filed with the court, whichever is later.
This time frame gives you a limited window to reconsider your decision. To formally rescind the agreement, you must notify the creditor and the court in writing. Keep copies of all correspondence as proof that you requested the cancellation within the allowed time.
Once the reaffirmation agreement is canceled, the debt becomes part of the bankruptcy discharge, meaning you are no longer obligated to pay it. The creditor cannot take legal action against you for the debt, but they may still repossess any collateral tied to the loan.
Consider your options carefully before deciding to cancel. While it can provide immediate financial relief by eliminating the obligation to repay the reaffirmed debt, it also means losing the asset tied to that debt. Additionally, canceling the agreement might impact any efforts to rebuild your credit after bankruptcy.
The bottom line
A reaffirmation agreement can be useful during Chapter 7 bankruptcy if you want to retain essential assets like a car or home and rebuild your credit. However, a reaffirmation agreement comes with significant financial responsibility, as you remain liable for the reaffirmed debt even after bankruptcy.
It’s crucial to weigh the benefits, such as keeping valuable property, against the risks of ongoing financial obligation. Always ensure you fully understand the terms of the agreement and your ability to meet the payments before proceeding and seek legal guidance if necessary.
