Mortgages and Bankruptcy
by Adam Weiner
When someone files a chapter 7 bankruptcy, all liabilities and assets (including the approximate quick liquidation value of the assets) are included in the bankruptcy petition. The liabilities listed include everything, including non-dischargeable debt (among other things, certain taxes are not dischargeable, student loans are generally non-dischargeable, child/spousal support is not dischargeable).
(People often have a misperception regarding a liability that is “included in the bankruptcy.” All liabilities must be listed in the debtor’s bankruptcy petition, even though they may not all be subject to discharge. Thus, listing a liability is a requirement but that does not mean that the liability will be discharged.)
Secured loans are treated differently in bankruptcies. If someone has a car loan and they are current on the payments and intend to keep the car, then they can sign a reaffirmation agreement with the creditor. This reaffirmation agreement will then be filed with the court. The judge will need to approve this reaffirmation agreement, but ordinarily will approve the reaffirmation agreement if the debtor’s bankruptcy petition shows that they can afford the payments (the debtor’s income and monthly expenses are also part of a bankruptcy petition). Assuming that a reaffirmation agreement is signed by the debtor and creditor, filed with the court, and approved by the judge, then that specific debt (e.g., the loan on the car) will survive the bankruptcy without it being discharged. This means that in addition to repossessing the car upon default (the bankruptcy would not have eliminated the lien that the lender had on the car), the lender will be able to potentially sue the debtor post-bankruptcy for a deficiency balance (i.e., if the car is sold at auction post repossession for less than what is owed on the loan).
Traditionally in Oregon, mortgages are not reaffirmed in a bankruptcy case. This does not mean that a debtor cannot keep their house if they file a bankruptcy. Indeed if the debtor is current on the mortgage payments and stays current, they will not lose their house notwithstanding the bankruptcy filing. But if subsequent to the bankruptcy filing the debtor ever stopped making mortgage payments and the house was foreclosed, the mortgage lenders would not be able to sue the debtor for any deficiency (of course, the liens would survive the bankruptcy and, thus, the lenders could foreclose after a bankruptcy if the debtor stopped making payments; the lender would have to go through the normal foreclosure process).
Recently there has been a discussion among bankruptcy attorneys regarding the potential benefits of reaffirming a mortgage in a bankruptcy case. One difference with other reaffirmation agreements is that the judge will not need to approve a reaffirmation of a mortgage in a bankruptcy case. Thus, the reaffirmation will be valid after it is signed by the debtor and creditor and then filed with the court. Some lenders are refusing to refinance mortgages for debtors who have gone through a bankruptcy and not reaffirmed their mortgage. Also, lenders will not normally report post bankruptcy mortgage payments to the credit reporting bureaus if there was not a reaffirmation. Are these two reasons, good reasons to go against what has been traditionally recommended by bankruptcy attorneys in Portland regarding not reaffirming a mortgage?
Remember, reaffirming the mortgage will mean that the debtor is still liable on the note (in addition to the lien being valid, of course). Is there a risk of a deficiency lawsuit against a bankruptcy debtor who reaffirmed a mortgage? If the house remained the debtor’s residence, then the foreclosing bank cannot sue for a deficiency balance, even if the debtor did not file a bankruptcy. But if there are multiple mortgages on the house, the second mortgage would be able to sue the debtor for a deficiency (unless the second mortgage was owned by the same bank as the first mortgage and it was used to purchase the house). Thus, if a debtor in a bankruptcy reaffirmed both mortgages in a bankruptcy and then subsequent to the bankruptcy the house was foreclosed, then the debtor could be sued for a deficiency on the second mortgage. Hence, it is usually a really bad idea to reaffirm a second mortgage. One potential risk of a deficiency on the first mortgage would be if the house becomes a rental house at some point in the future and then the debtor defaults and the bank files a judicial foreclosure lawsuit. In that scenario, there would be a possibility of a deficiency against the debtor if the debtor had reaffirmed the first mortgage in the bankruptcy. Another risk of reaffirming the first and/or second mortgages would be if there was a post-bankruptcy short sale of the property and the bank(s) did not waive their deficiency rights.
Additionally, there are potential tax implications of reaffirming a mortgage in the bankruptcy if post-bankruptcy there is a write off of some or all of the liability associated with the mortgage by the bank in a short sale. If the mortgage was not reaffirmed in the bankruptcy, then there would never be any danger of cancellation of debt tax liability based on that mortgage. Thus, does it make sense to reaffirm a mortgage for the potential benefit of a future loan refinance and post-bankruptcy reporting of payments to the credit bureaus? Indeed it is important to reestablish credit after a bankruptcy filing, but there are other ways to do this then having the post-bankruptcy mortgage payments reported to the credit reporting bureaus (e.g., I recommend that all of my bankruptcy clients obtain secured credit cards from their bank or credit union to start rebuilding their credit).
The potential future loan refinance that might not be available to a debtor who has not reaffirmed their mortgage in their bankruptcy may be a valid reason to consider reaffirming a first mortgage (I would never advise reaffirming a second mortgage). But the truth is that the bankruptcy discharge of the mortgage note, without a reaffirmation, does not prevent the bank from refinancing the mortgage post-bankruptcy. Nonetheless, the banks seem to be currently operating on this premise. Thus, it is a valid consideration for a debtor with a mortgage who files a bankruptcy. As with any issue regarding a potential bankruptcy filing, it is important to speak with an experienced bankruptcy attorney in Portland to analyze your unique situation. Feel free to give my office a call and we can discuss your situation and schedule an appointment, if appropriate.