Recently I moderated a program for bankruptcy attorneys which dealt with this scenario:
a Chapter 7 bankruptcy is filed. My clients, the debtors, have one or more mortgages on their home. All fine and good so far. We have a discussion about whether to "reaffirm" any debts. When you reaffirm a debt it means that you continue to be personally liable on the debt, despite your bankruptcy discharge. Of course, a bankruptcy discharge of your debts is why you filed in the first place, right?  Sometimes the clients reaffirm an automobile loan. We talk about whether they should reaffirm any of the mortgage debts. I advise them not to reaffirm  the mortgages. The bankruptcy closes and the clients receive their discharge.

A year later the former clients contact me, frustrated because they have attempted to refinance one or more of their mortgages for a lower interest rate. Their mortgage broker has contacted the existing lender, say Wells Fargo or Bank of America, and the banks tell the broker they can't do the refinance because the debtors did not reaffirm the mortgage in bankruptcy. And now my clients want to know why didn't I advise them to refinance the mortgage, or what can they do now to reaffirm the mortgage.

The painful answer is that most bankruptcy attorneys (almost all, in fact) never allow their clients to reaffirm a home mortgage. Some attorneys think it's malpractice to do otherwise. I won't get into those reasons here, other than to say (a) by reaffirming you lose the discharge of your personal liability for the loan; and (b) it's not necessary to reaffirm a mortgage to keep your home. I have debated this issue with many bankruptcy lawyers, including attorneys representing banks, and they all admit that reaffirmation is probably a bad idea.

Why do these banks refuse to refinance? I used to think it was a subtle way to punish debtors for not reaffirming. After all, by discharging their personal liability on the mortgage, the debtors get a "leg up" on the lender; if they default on the mortgage and lose the property in foreclosure, the lender cannot sue them for the unpaid debt. I've changed my mind. The real reason why these lenders don't refinance without a reaffirmation is because the Bankruptcy Code says that entering into such a refinance violates the debtor's discharge, which could leave the lender open to a "sanction". That sanction could be a money fine or the voiding of the refinance, or both. See 11 U.S.C. 524(a)(2) and (c). This is the real reason. 

I have also been told by bank attorneys that without a reaffirmation in place the banks cannot sell their loan on the secondary market, i.e., to Freddie Mac or Fannie Mae. This may or may not be correct, but the important thing is that the bank believes this and you're not going to convince them otherwise. 

So can the clients reopen their bankruptcy case and reaffirm the mortgage? Nope; the reaffirmation had to be made before the entry of the discharge.

So what are the realistic options available to debtors? First, this problem only arises when you are asking the lender who holds the existing loan against the property. You are free to find a new lender and refinance. Reaffirmation - or the failure to reaffirm - is not a problem for the new lender.

The problem with finding a new lender is that lender wants a record of your payment on the old mortgage. Guess what; one of the consequences of obtaining a bankruptcy discharge is that the existing lender stops reporting your payments on your credit report. Lenders believe that reporting a debtor's performance on a loan  violates the bankruptcy discharge. Here I should explain that the legal effect of an discharge is an injunction which prohibits a creditor from taking any action to collect a debt which arose before bankruptcy. Lenders have legitimate reason to fear that by reporting loan performance renders them liable for sanctions; a number of cases exist where an erroneous credit report has led to sanctions. And face it, reporting a "late payment" on a credit report is a form of collection, isn't it?

How to get around the lack of a credit report? Ask your lender for a payment transcript and provide it to your loan broker.

Of course, these secondary lenders are likely to charge a higher interest rate and finance charges than the original lender. That I don't have an answer for.

I hope you find this discussion helpful. You should not rely upon this information without first seeking professional legal counsel from a licensed attorney concerning your particular circumstances or case. I am required under federal law to disclose that my firm may be considered a debt relief agency that helps people file for bankruptcy relief under the Bankruptcy Code. The transmission or receipt of this information, or any correspondence arising therefrom, will not create or constitute an attorney-client relationship.


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