Authors explain how to duck debt reaffirmation traps
When seeking bankruptcy protection, some unwary consumers may be cajoled or outright conned by their creditors into remaining on the hook for a car loan or home mortgage through a process known as reaffirmation.
In most instances, reaffirmation is unwise for the debtor because it waives the debtor's right to then discharge that debt and make a "fresh start" under Chapter 7 bankruptcy law.
How to keep from shooting yourself in the foot by reaffirmation?
A new book, "Reaffirmation Agreements in Consumer Bankruptcy Cases," published by the American Bankruptcy Institute, explores the pitfalls of reaffirmation and the new personal bankruptcy landscape in the wake of the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 (BAPCPA).
CreditCards.com spoke with the two bankruptcy attorney authors, Dan Austin of Pittsburgh, who generally represents creditors, and Don Lassman of Needham, Mass., who represents debtors, to discuss reaffirmation for consumers.
CreditCards.com: Where do debtors typically go wrong when it comes to reaffirmation?
Don Lassman: They reaffirm a debt that they can't reasonably afford. There is something called "debtor's euphoria," where debtors are just eternally optimistic. I think their tendency is to hope things will always get better - "I know I'm close but next month I might make more money" - and then they reaffirm a debt that they cannot afford. And once it's reaffirmed, they're on the hook for that. So if they subsequently lose the collateral, they have to pay the deficiency.
I have a woman working five jobs to keep her house and I have sat her down time and time again, telling her, "You have got to let this house go. You cannot make that mortgage payment. You just can't." I would not let her reaffirm that debt, but if she were on her own, without counsel, she would have reaffirmed that debt. And it's several hundred thousand dollars more than the value of the house!
Dan Austin: It is stunning the myopia that some people have for years and years and years, thinking they can afford this or that - this house, this business, this lifestyle. It's astonishing. Mind boggling.
CreditCards.com: Doesn't bankruptcy court serve to save them from themselves?
Lassman: Yes, the court is a referee and can prevent debt. But sometimes their income and expense schedules will be closer to the vest to where hey, maybe we can make it, and then there's a job loss.
Austin: Or they understate their expenses or overstate their income.
Lassman: That's right, so when they're before the judge, the judge has a series of expenses and income that may not be wholly correct because the debtor just wants to do something to keep his collateral.
CreditCards.com: BAPCPA attempted to eliminate the so-called "ride-through" option, which prevented creditors from repossessing the collateral as long as the debtor stayed current on the payments. Despite this, does "ride-through" live on?
Austin: Let me approach this from the creditor's perspective. The drafters of the amendment did not want creditors to be able to keep personal property that was secured by a lien and yet have their personal liability for that debt discharged in bankruptcy.
Creditors felt that, if you're going to keep our stuff and get the benefit of the deal that you got from us, then we want you personally on the hook. So in the revised section of the code, they intended to take that choice away from debtors. If you're going to keep security collateral, then you have to reaffirm and be personally responsible for the debt. If you don't want to be personally responsible, then give us back our stuff.
I think, in a very unsophisticated way, that they tried to throw out "ride-through," but either they knew it would still exist or they were so shortsighted that, in effect, it really does seem to still exist - not so much as a legal matter but as a practical result.
Lassman: I would say that the bankruptcy cases that are starting to come down suggest that "ride-through" rides on. And to the extent they don't, as a practical matter, what debtors do is, they may file their bankruptcy and say they are going to reaffirm, and then the creditor sends them the reaffirmation agreement and they amend and say nope, I'm not going to reaffirm, I'm just going to keep paying.
The practical fact is, with most of my clients, some will reaffirm but many will not, and those that do not just simply keep paying and that's the end of it. Because, as a general rule, creditors would much rather have money than property back.
Austin: Totally so. I would say that, of the reaffirmation agreements that I send out, I may get back half, or fewer.
CreditCards.com: Debtors tend to think possession is nine-tenths of the law, and you're going to have to come and take it from me.
Austin: And you know what? If they stop paying, we will come and take it from them. But as long as they're paying, we don't want to own the stuff again. It makes no practical sense for us to go out and grab it.
CreditCards.com: It doesn't make sense for a debtor to reaffirm credit card debt, right?
Lassman: I don't think the bankruptcy court would allow it because, unless as their lawyer I sign that reaffirmation agreement, there's going to be a hearing on it. And I won't sign it; as a debtor's lawyer, I would never recommend that a creditor reaffirm a credit card debt. And how would he choose which one? It's contrary to the purposes of Chapter 7.
A lot of bankruptcy judges won't allow debtors to reaffirm mortgage debt or car debt; I don't think a bankruptcy judge would allow a debtor to reaffirm a credit card debt. I think it would be very unusual.
Austin: Many creditors will still make that offer - that if you reaffirm, you'll only reaffirm so much, we'll give you a secured credit card.
Lassman: They can go out and get a secured credit card right after they file bankruptcy anyway. Why should they saddle themselves with the old debt?
CreditCards.com: Sure, because unlike a car or house, credit card debt is unsecured debt.
Lassman: The only thing I can see a client reaffirming is a house or a car. Period, end of story. And then, only if there is equity and they have the ability to pay. If there's no equity, it becomes very difficult. I wouldn't consider anything else.
Austin: Everything Don says is accurate from a debtor's perspective. I do see some value in reaffirming an auto debt even if there is no equity. For one, in the few states where the creditor may really try to grab the collateral back, it may be the only way for the debtor to keep the car. Since the debtor is going to keep the car anyway, and since the payments will continue to be reflected on their credit report, I think there's some value to reaffirm. Those payments on a big-ticket item that you're going to pay off anyway will continue to go on your credit report, so why not get the credit for paying them off?
CreditCards.com: If they don't reaffirm those, they won't show on their credit report?
Austin: There is still a bit of flux in the country on this, but in California for example, it is quite clear that if you didn't reaffirm your vehicle debt, the credit reporting agency has to show that debt as a zero balance on your credit report, even if you continue to pay it and eventually pay it off. If it has been discharged in bankruptcy, it has to be a zero balance on your credit report. But if you reaffirm, credit reporting agencies will continue to report it as a payment on your credit report. For some debtors, that's a good reason to reaffirm.
CreditCards.com: Having a co-debtor sometimes changes the landscape as far as reaffirmation is concerned.
Lassman: Well, if there is a co-debtor, it might be easier to reaffirm because one of the things you could say to the judge is, "I have a nonbankrupt co-debtor and I'm certain that they will step up and make the payments." So that might be a reason for reaffirmation because you have an additional income source.
CreditCards.com: Consumers get into tricky waters when their debt is through a credit union where secured debts such as auto loans may be mixed with unsecured credit card debt through what is called cross-collateralization. Does this pose a threat to a debtor who is considering reaffirmation.
Austin: Yes, definitely. Credit union security agreements typically contain cross-collateral provisions -- the slang term is "drag nets" -- and it may be for a blanket amount, where you put your car and your credit card on that. So if you reaffirm the car portion of that security agreement, it typically spreads to the unsecured portion as well. So you've also reaffirmed the unsecured portion as well.
Lassman: Which is why you have to read very carefully the reaffirmation agreement when it comes back from the creditor, to make sure that the amount is what you think it is.
Published: May 4, 2009
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