What Is a Reaffirmation Agreement and How Do You Use One?

People who file bankruptcy are often concerned about what's going to happen to their car. Signing a reaffirmation agreement is one option that lets you keep your car and continue making the payments, but it's not the only option and might not be the best option in your situation. Read on to learn about how reaffirmations work and factors to consider when deciding whether to sign a reaffirmation agreement.

What Is Secured Debt? 

A secured debt is connected to specific property, the collateral that secures the loan. The most common secured debts are mortgages, which are backed by real estate and car loans, which are secured by the vehicle. The creditor of a secured debt — known as a secured creditor — has the right to repossess the loan's collateral or force a sale if the borrower doesn't make the payments. 

In cases of car repossession, the secured creditor will typically sell the vehicle and use the proceeds to cover the remaining balance on the loan. If the car sells for less than the amount owed on the loan, then the borrower still owes that deficiency balance. The creditor can attempt to collect the deficiency amount from the borrower. 

Why Do I Have To Reaffirm Secured Debt?

At the end of a successful Chapter 7 bankruptcy case the filer receives a bankruptcy discharge, which erases their personal liability to pay back certain debts. Although the filer will no longer be personally liable to pay back a secured debt, the loan is still connected to the property. A secured creditor retains their security interest and the right to repossession, but can't collect on a deficiency balance unless the filer reaffirms the debt through a reaffirmation agreement.

The United States Bankruptcy Code requires secured debts for personal property to be reaffirmed, but this was not always the case. Before the 2005 amendments to the Bankruptcy Code, as long as the filer stayed current on their car payments before, during, and after Chapter 7 bankruptcy then they could keep their car. This was known as the ride-through option. 

Under the ride-through option, when a borrower didn't keep up with their car loan payments after bankruptcy the creditor could repossess and sell the car but wasn't allowed to collect on any deficiency amount after sale. Creditors didn't like this and didn't want ride-through to be an option anymore.

The ride-through option for personal property was eliminated in the 2005 Bankruptcy Code amendments. Now bankruptcy filers are required to enter into reaffirmation agreements on secured debts for personal property. This means the bankruptcy discharge won't apply to the reaffirmed debt and the filer will continue to be personally liable for the debt, including any deficiency amount if they later default on payments. Reaffirmations are designed to protect the secured creditor. The Bankruptcy Code doesn't require reaffirmations for debt secured by real property, like your home mortgage. 

Should I Reaffirm My Car Loan? 

Just because the U.S. Bankruptcy Code requires you to reaffirm your secured debts, you don’t have to do so. We’ll cover the alternatives to reaffirmation a little later in this article. For now, let’s explore the factors to consider when deciding whether you should reaffirm your car loan.

Filing for bankruptcy protection is meant to give you debt relief and a fresh start. If you reaffirm your car loan and later default on it, you could end up back in debt that you can't afford to pay. For this reason, it's important to carefully consider if reaffirmation is right for you. 

• Can you afford your monthly payment? If you can't reasonably afford to make the monthly payment, then it may be best to consider alternatives to reaffirming your car loan. 

• Do you have equity in the vehicle? Equity is the value of the vehicle above the amount owed. A reaffirmation agreement is less risky if the car is worth more than you owe. If you can't make your payments, the sale of the car will cover the debt and you won't be on the hook for a deficiency balance. On the other hand, a reaffirmation agreement is a lot riskier if you have negative equity and owe more than the car is worth, especially if a loan from a prior vehicle was rolled in. If you can't make your payments later, you'll be on the hook for the full deficiency balance – which could be a lot of money. 

• What's the condition of the vehicle? Consider if the vehicle is in good working condition and worth keeping. If the vehicle has damage or needs or will soon need major repairs, it may be better not to reaffirm the debt as you already know that you’ll have to put even more money into the car down the road. 

• Is this the family's only car? You may need a car to get to work or get your kids to school, but your family may not need more than one car. Evaluate if it's truly necessary to reaffirm this particular debt if your family has another vehicle that's protected through bankruptcy and can get your family where they need to be. 

Also, if you're already behind on your car loan payments, reaffirmation may not even be possible. Typically, to keep a car with a loan through a Chapter 7 bankruptcy filing you must be current on the payments and maintain insurance on the vehicle throughout the bankruptcy proceeding.

What Steps Are Involved in Reaffirming a Debt?

The process of reaffirming a debt is exactly that: a process. It starts with letting your creditor and the court know that you plan on reaffirming a certain debt in the Statement of Intentions (Official Form 108) you file with your bankruptcy forms. Let’s take a look at what happens next.

How Do I Get a Reaffirmation Agreement?

The creditor will usually send the reaffirmation agreement by mail to the debtor's attorney or directly to a pro se filer (people who file without an attorney). It's not uncommon for the reaffirmation agreement to be sent before the meeting of creditors, which happens about a month after filing. The completed reaffirmation agreement needs to be filed within 60 days after the first date set for the meeting of creditors. 

The Cover Sheet for Reaffirmation Agreement (Official Form 427) needs to be attached to the signed reaffirmation agreement. The cover sheet can be filled out by anyone who is a party to the agreement. The cover sheet and reaffirmation agreement signed by the filer is sent back to the creditor. 

What’s a Presumption of Undue Hardship?

A presumption of undue hardship arises when a filer's expenses exceed their monthly income. This shows there isn't enough money to cover the monthly payment that would be required by the reaffirmation agreement. When a presumption of undue hardship arises, the cover sheet requires the filer to explain how they'll make monthly payments on the reaffirmed debt and pay other living expenses. 

What Happens After I Send the Reaffirmation Agreement to the Creditor?

Reaffirmation agreements that are certified by the filer's bankruptcy attorney are immediately binding and don't require a hearing. However, often bankruptcy attorneys won't sign off on reaffirmation agreements, especially when there's no equity in the vehicle. If you're in this situation, it's probably best to talk directly with your bankruptcy attorney about their reasons for not signing the reaffirmation agreement in your bankruptcy case. 

If the filer doesn’t have a lawyer who signs off on the reaffirmation agreement, then the agreement has to be approved by the bankruptcy court for it to be binding. Court approval is handled in different ways in different districts, but typically involves a reaffirmation hearing.

The Reaffirmation Hearing

At a reaffirmation hearing, the judge will ask questions to determine whether the court should approve or deny your reaffirmation agreement. Typical questions include whether you're current on the loan payments, whether there's equity in the vehicle, whether you understand the terms of the agreement, why you want to reaffirm this debt, and whether your monthly expenses exceed your income, and if so, how you plan to afford the monthly payments of the reaffirmation agreement.

If the judge doesn't approve the reaffirmation agreement – it's generally considered a good thing. Your personal liability on a secured debt that isn't reaffirmed will be discharged. Even if you default on payments later, the creditor won't be able to come after you for a deficiency balance.

Further, a secured creditor wants an approved reaffirmation agreement. If the court rejected the reaffirmation terms, then your creditor may be willing to offer a better deal, like a lower interest rate. The court might approve a revised reaffirmation agreement that’s better for the filer. 

If the reaffirmation agreement is not approved, most secured creditors will still allow you to keep the car as long as you continue to make payments and keep the car insured. This is because in most situations the creditor is better off with the monthly payments than it would be if it repossessed the property and sold it. 

Alternatives To Reaffirming Your Car Loan

Chapter 7 bankruptcy offers other options for dealing with a car loan, including redemption and surrender. 

Redemption in bankruptcy means paying the lender the value of the vehicle. This might be an option if your vehicle is worth significantly less than the amount you owe and you're able to make a lump-sum payment covering the value of the vehicle. You may want to consider redeeming a vehicle by getting a private loan from a friend or family member, or exploring a redemption loan at 722redemption.com. 

You can also surrender your vehicle. If you choose to surrender, your creditor will repossess the vehicle and the debt will be discharged in your bankruptcy. Any deficiency balance would be discharged, too. 

Let's Summarize...

You have options for what to do with a car loan when filing a Chapter 7 bankruptcy case. A reaffirmation agreement can lead to new debt problems if you later default on your loan payments. After your debts are erased by a Chapter 7 discharge, you can't file another Chapter 7 bankruptcy for eight years. Reaffirming a car loan is risky because of the limits on how often you can file for bankruptcy protection. It's not a bad idea to speak to a bankruptcy lawyer about all of this if you're not sure what to do about your car.

Learn more about your debt relief options with a free bankruptcy evaluation. If you can't afford a lawyer to help you file a Chapter 7 bankruptcy, Upsolve may be able to do so. Eligible filers can use Upsolve's free web app to prepare their bankruptcy forms.