What Is a Reaffirmation Agreement?

Anyone new to bankruptcy can’t be blamed for thinking the whole process equals doom, gloom, and forfeiture. After all, filing bankruptcy is not going to look good on your resumé or credit report, and, for Chapter 7 filers, there’s grim talk about “liquidation.”

Take heart: The worst is not necessarily inevitable.

For Chapter 7 bankruptcy, filers shouldering loans secured by valuables they want — check that: need — to keep, the code provides an escape clause. By invoking a tactic known as a reaffirmation agreement, a debt-wracked consumer can hold onto cherished collateral that otherwise might be seized and liquidated by the bankruptcy court’s trustee.

A reaffirmation agreement is a legal contract in which a debtor commits to repaying a specific (usually secured) debt, even after a successful discharge.

With one or more court-approved reaffirmation agreements, all manner of valuable collateral used to secure a loan can be retained. Examples include an engagement ring or other expensive jewelry; a family heirloom that secures a personal loan; tools or equipment vital to the family business or sole proprietorship; or undeveloped property used for hunting and/or camping.

Typically, however, reaffirmation agreements protect vehicles and, sometimes, houses. It depends.

“Because a reaffirmation agreement undermines the benefits of bankruptcy by holding you liable for a debt bankruptcy would erase, you’ll want to use it only when necessary, and whether you’ll need reaffirmation agreement protection will depend partly on your state’s law,” says Cara O’Neill, a Roseville, Calif.-based bankruptcy attorney. “For instance, in California, a lender can’t use lien rights to foreclose on a residential home if the homeowner is current on the payments, so reaffirmation agreements are rarely used for homes in California.”

The upsides to reaffirmation agreements are both obvious (the bankrupt keeps valuable property important to him/her) and subtle (harm to the bankrupt’s credit score will be less). But the downsides are ominous: loss of bankruptcy protection, long-term financial commitment, and potential for default proceedings and repossession if the loan sours.

The Purpose of a Reaffirmation Agreement

Understand this from the top: Reaffirmation agreements are entirely voluntary. A successful discharge releases debtors from having to pay any debts covered by bankruptcy.

We’ll discuss this at some length below.

Reaffirmation agreements serve several useful purposes for the bankruptcy-filer. Chief among these is the consumer keeps his/her valuable property — a house, a car, tools of the trade, or other essential property.

Additionally, reaffirmation puts a bankrupt in better stead with credit-reporting agencies. The Big Three (Experian, TransUnion, Equifax) note both the fact of the reaffirmation and the (knock on wood) regular, punctual payments under the new agreement, resulting in higher post-bankruptcy credit scores.

Attorney Christina Vilaboa-Abel, founder of Coral Gables, Fla.-based CAVA Law, explains it this way:

“Because the reaffirmation agreement reflects debt that is in good standing during and after the bankruptcy when a reaffirmation agreement is included by a debtor within the bankruptcy case, the creditor will, more likely than not, report it positively to the credit bureaus, which will help the debtor’s credit score increase faster post-bankruptcy.”

For consumers reliant upon the good graces of creditors — unincorporated small business owners or sole proprietorships, for instance — reaffirming a loan can help those relationships. Suppliers aren’t likely to extend favorable status to clients who have stiffed them. Reaffirmation agreements can help avoid all that unpleasantness.

“Reaffirmation is a sign of good faith, showing creditors you plan to repay your loan,” Mark Hirsch, a partner with Templer & Hirsch in South Florida, said. “This could lead to better terms and less aggressive collection.”

Similarly, reaffirming a car loan can mean keeping a vehicle for commuting and/or carrying out errands essential to your personal life.

Other relationships also may be in play. Debtors who enlisted a cosigner or guarantor to help secure a loan may leave this supportive relative or friend on the hook if they fail to reaffirm the loan. Wait on that.

“Using a reaffirmation agreement on an un-collateralized or ‘unsecured’ debt would be unusual,” says O’Neill. “A bankruptcy filer who feels a moral obligation to repay a debt to a friend, family member, or business associate can repay a creditor voluntarily after bankruptcy.”

It’s vital to understand that reaffirmation binds you personally to the affected debt; it will remain even after your bankruptcy discharge. Furthermore, you are liable for any deficiency balance if the property is damaged or destroyed, or if you default on the note.

Here’s what that means: You reaffirm your car loan, but wind up unable to maintain the payments. You default, whereupon the lender repossesses the car, and then sells it at a loss to a quick-sale dealer. You’re responsible for the difference between the loan balance and what the car sold for.

Rather than bind themselves to a fresh legal document, however, some borrowers who are current are tempted to keep making loan payments without going through the reaffirmation process, a tactic known as “drive-through” in bankruptcy circles.

For bankrupts with car loans, that’s a good way to get your vehicle repossessed, says Tampa, Fla.-based federal bankruptcy judge Catherine Peek McEwen.

Some lenders are “going pop your car even if you’re current if you don’t reaffirm that loan,” McEwen says. “They’ve made a policy decision that they do not want to staff a separate office of bankruptcy collectors who have to collect on un-reaffirmed loans and risk a violation of the discharge injunction, because that’s sanctionable.

“So that’s their bright line. They don’t care if you’re current. ‘Good for you. We’re taking your car.’ ”

Moreover, simply continuing to make payments post-bankruptcy is unlikely to boost your credit score. Says CAVA Law’s Vilaboa-Abel, “Although a creditor is not legally precluded from positively reporting current payments to the bureaus if there is not a reaffirmation agreement in the case, we have seen that many creditors actually hesitate to report to the bureaus even when the debtor is in good standing on that particular account.”

The Legal Process of Reaffirmation

A reaffirmation agreement establishes a contract between the debtor and creditor that lays out the details binding each party. It is, then, a legal arrangement bound by steps laid out in law.

When a debtor files for bankruptcy, he or she meets with the bankruptcy trustee assigned to the case in what is known as a 341(a) hearing, or “meeting of the creditors.” Following the meeting, the debtor has 45 days to sign and file with the court a reaffirmation agreement, or return the collateral to the creditor.

Forms involved include a Statement of Intentions (Official Form 108), and two documents completed in consultation with the creditor: Form 27 (reaffirmation cover sheet) and Form 240A (reaffirmation agreement).

A lawyer representing the bankruptcy filer can sign off on the reaffirmation agreement. Debtors representing themselves must have their reaffirmation agreement approved by the bankruptcy judge. The process involves a hearing before the judge in which the debtor must explain why he or she wants to reaffirm the debt and how they can afford to keep up with those future payments. The judge must be persuaded that the terms of the reaffirmation agreement will not result in undue hardship for the debtor.

Key factors guiding the lawyer’s or judge’s decision:

• The loan is not secured.
  • The applicant doesn’t have, or earn enough money to maintain the payment schedule.
  • The interest rate is too high.
  • The property is worth less than the balance of the loan.

Failure to follow the legal process correctly can render the reaffirmation agreement unenforceable.

Pros and Cons of Reaffirmation Agreements

As with virtually any significant financial decision, entering into a reaffirmation agreement presents benefits and detriments. You keep the car, but you also keep making payments. Your credit score suffers less, but you lose bankruptcy protection on the reaffirmed debt.

But wait, there’s more.

Advantages of Reaffirmation Agreements

Upsides to reaffirmation agreements explain their attractiveness, even to someone desperate to get out of debt quickly. Reaffirmation allows you to:

• Hang onto valuable assets that might otherwise be repossessed.
• Speed up the process of rebuilding your credit score, making you a better candidate for better borrowing terms in the near term.
• Maintain favorable relationships with creditors you’ve agreed to pay.
• Negotiate, potentially, new, and better terms on the loan(s) you reaffirm. A reaffirmed auto loan, for instance, is certain to have an interest rate pegged to between one and three points above prime.

By keeping the family home and/or a much-needed car, reaffirmation also may a modest share of stability in the debtor’s post-bankruptcy life.

Disadvantages of Reaffirmation Agreements

Reaffirmation agreements are not without pitfalls. By reaffirming a loan, you sacrifice bankruptcy protection on it for eight years. If you default on your payments and the collateral is repossessed, you’ll remain on the hook for the deficiency; the creditor may sue to collect, up to and including garnishing your wages.

Even if you’re able to maintain your payment schedule, you may be inviting ongoing financial strain, which bankruptcy was supposed to alleviate in the first place.

In short, reaffirmation is a grave financial commitment, not to be entered into simply because you like something, or you want it. If you don’t absolutely, positively need the secured valuable, or if you could replace it with something less financially burdensome, reaffirmation might not be your best option.

Alternatives to Reaffirmation Agreements

If you’re a fan of complicated scenarios, you’re going to love this. Angling to keep needed property despite going through Chapter 7 bankruptcy presents more possibilities than an Agatha Christie mystery. But similar to Dame Agatha’s whodunits, it’ll most likely all work out in the end.

One option we’ve touched on above, and it could make perfect sense: Surrender the collateral. Yes, you love your Cirrus Silver Metallic 2023 Mercedes Benz GLS with Driver Assistance Package Plus, but that was before the downsizing. Now that you’re getting back on your feet, rather than reaffirm the loan and its $1,850 monthly payment, you could be better served to let that sweet ride go in favor of a reliable, low-mileage, low-cost, late-model SUV to get from here to there. They’re out there, and even bankrupts can score comparatively acceptable terms.

Another option: Redeem the property. If you have access to the resources, or can score a loan under favorable terms, and you categorically need the property staked to the loan, you can see about negotiating a single, lump-sum payment to the lender for the collateral’s current fair market value.

Finally, attempt to negotiate a settlement with the creditor. You are not without advantages here. As Judge McEwen notes, “Trustees always believe that the best market for your car is you.” The same applies to other collateral in your possession. Find out what it will cost to make the loan go away, and how long you have to come up with the money.

Throughout all of this, remember: Reaffirmation agreements are strictly voluntary; so are the other strategies described above. The goal is to   get you to your fresh financial start without the ongoing burden of debt repayment(s).

Who Should Consider a Reaffirmation Agreement?

Reaffirmation agreements are not for every debtor. If you are still on shaky financial ground after emerging from a discharge, you are not a good candidate for reaffirmation.

However, not all reaffirmations are created equal. There are some reaffirmation that even people on firm financial foundations, should avoid. Such as? Reaffirming a debt for property that is worth less than the balance, for instance, or that will continue to carry an onerous interest rate.

Factors to consider when weighing your reaffirmation options:

• Your post-discharge financial stability.
• You have firm, demonstrable reasons to believe you can make the payments.
• No other strategy will allow you to keep the property, and it is definitely needed.

Reaffirming a debt may be the only practical method you can keep the property you depend on, such as your home or vehicle(s). There is wisdom, too, in reaffirming debts on collateral that are worth substantially more than you owe on it. Remember, too, that you can attempt to negotiate the terms of your loan.

“It never hurts to ask,” attorney O’Neill says. “How effective the negotiation will be will depend on whether it will be more profitable for the lender to work with the debtor or recover the property and sell it to someone else.”

All that said, reaffirming a debt for more than it would cost to replace the property is rarely a better option.

Making an Informed Decision

While bankruptcy is designed to give debtors a fresh start, getting successfully past the finish line is a complex process riddled with legal potholes. This is particularly true of reaffirmation agreements. What appears to be a reasonable course of action can backfire on the most well-meaning bankruptcy filer.

Give painstaking consideration to your reaffirmation options. Do you truly need the secured property? Is it replaceable at a lower cost? Are you asking for trouble down the line? Are there better strategies? Does the creditor know things I don’t?

Reaffirmation is “for folks who need the asset and can afford the payments,” says Milly Barker, a financial advisor and founder of RemotePad. “If you’re unsure, don’t go it alone. A bankruptcy attorney can be your financial lifeline.

“Bankruptcy’s a fresh start. Don’t let reaffirmation agreements drag you back under.”

What Barker said: As you pander to your bankruptcy choices, make consultation with a bankruptcy attorney, financial advisor, or nonprofit credit counselor part of your game plan. Everyone with whom you will be dealing benefits from legal counsel and/or financial experts. Failing to add professional expertise to your team puts you at a distinct disadvantage.