One of the most difficult decisions for bankruptcy lawyers and debtors is whether to “reaffirm” debts that would otherwise be discharged in bankruptcy. Reaffirmation means a debtor agrees to still be responsible for debts even though the bankruptcy discharges their personal liability. Reaffirmation agreements are usually only signed on secured debts like mortgages and car loans. Secured debt against the property itself will survive bankruptcy but the personal liability for a debt is discharged unless reaffirmed. Reaffirmation is never advisable where the risk of not being able to continue making the payments is high. If a debtor defaults on payments after bankruptcy, a secured creditor could collect the debt while the debtor is unable to file another bankruptcy for several years.
I have generally advised against reaffirmation agreements unless the creditor is willing to make concessions on loan terms. In Iowa, creditors are prohibited from taking property where loan payments are current, so I’ve never thought reaffirmation is necessary. The fresh start obtained in bankruptcy should be used to make a clean break from personal debt obligations. It’s possible to have home mortgages and car loans without being personally liable for debts that might become impossible to pay in the future.
Some bankruptcy lawyers, though, have thought there was some credit score benefit to debtors. It was felt that reaffirmation permitted creditors to continue reporting payments to credit bureaus, which would then help debtors “rebuild their credit” after bankruptcy. It was a widespread and long term myth that only recently got busted by a bankruptcy judge in California.
The California case involved a Chapter 7 bankruptcy debtor who was advised by her attorney to sign a reaffirmation agreement on a car loan with Wells Fargo Bank. The bankruptcy lawyer certified the reaffirmation was in his client’s best interest even though her budget showed unrealistic projections about her true living expenses and income. The bankruptcy judge became suspicious after looking at the budget and ordered that Wells Fargo Bank representatives and credit reporting experts testify as to the true consequences of reaffirmation. At trial, Wells Fargo Bank admitted it would not repossess vehicles where loan payments are current, even if there’s no reaffirmation. In addition, the credit reporting expert testified the impact of signing a reaffirmation agreement on a debtor’s credit score is none or very low. Even the reporting of payments on a debtor’s credit report is not beneficial from a scoring perspective. In fact, the credit expert said that the reporting of current payments after bankruptcy might backfire if a default after bankruptcy does occur. The more recent negative information would outweigh any benefit of the reported payments.
We now know that the one reason many bankruptcy lawyers and debtors thought reaffirmation was beneficial — reporting current payments on credit reports– really doesn’t create much benefit to a debtor’s credit score and may do more harm than good. Creditors like reaffirmation agreements because they keep debtors on the hook in the future. But this California case should make debtors and their lawyers even more reluctant to reaffirm debt in bankruptcy.