Mortgages and Bankruptcy
by Adam Weiner
Discharged V& NonDischargeable Debt
When someone files a chapter 7 bankruptcy, all liabilities and assets are included in the bankruptcy petition. The liabilities listed include even nondischargeable debt: certain taxes are not dischargeable, student loans are generally nondischargeable, and child/spousal support is not dischargeable
People 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.
What Does it Mean to Reaffirm Your Mortgage?
Secured loans are treated differently in bankruptcies. If someone has a car loan and is current on the payments, they can sign a reaffirmation agreement with the creditor. This reaffirmation agreement will then be filed with the court. The judge will approve this reaffirmation agreement if the debtor’s bankruptcy petition shows that they can afford 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. An example would be if the car is sold at auction post repossession for less than what is owed on the loan.
Do You Lose Your House if Your File a Chapter 7?
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. If the debtor is current on the mortgage payments and stays current, they will not lose their house notwithstanding the bankruptcy filing. 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).
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. The liens would survive the bankruptcy and the lenders could foreclose after a bankruptcy if the debtor stopped making payments; the lender would have to go through the normal foreclosure process.
Advantages & Disadvantages of Reaffirming a Mortgage
Recently there has been a discussion among bankruptcy attorneys regarding the 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. The reaffirmation will be valid after it is signed by the debtor, the 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.
Reaffirming the mortgage means that the debtor is still liable on the note. This is in addition to the lien being valid. If the house remained the debtor’s residence, the foreclosing bank cannot sue for a deficiency balance. This is so even if the debtor did not file a bankruptcy. If there are multiple mortgages on the house, the second mortgage would be able to sue the debtor for a deficiency. This is not true if the second mortgage was owned by the same bank as the first mortgage and it was used to purchase the house.
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 – it is a bad idea to reaffirm a second mortgage. One risk of a deficiency on the first mortgage would be if the house becomes a rental house in the future and then the debtor defaults. The bank could file 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.
There are tax implications in reaffirming a mortgage if post-bankruptcy there is a write off of the liability associated with the mortgage by the bank in a short sale. If the mortgage was not reaffirmed in the bankruptcy there would be no danger of cancellation of debt tax liability based on that mortgage.
It is important to re-establish credit after a bankruptcy filing. Having the post-bankruptcy mortgage payments reported to the credit reporting bureaus is not the only way to do this. I recommend obtaining secured credit cards from their bank or credit union to start rebuilding their credit.
Potential future loan refinances might not be available to a debtor who has not reaffirmed their mortgage in their bankruptcy. This is reason enough to consider reaffirming the first mortgage. I would never advise reaffirming a second mortgage. Without a reaffirmation, the bankruptcy discharge of the mortgage note does not prevent the bank from refinancing the mortgage post-bankruptcy.
Nonetheless, the banks seem to be currently operating on this premise. It is a valid consideration for a debtor with a mortgage who files a bankruptcy. 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.