Consumers who have a car loan and want to keep their car after finishing their chapter 7 bankruptcy should understand what a "reaffirmation agreement" is, and what its consequences are.
Reaffirmation Agreements & Car Loans
In order to learn about reaffirmation agreements, we must first understand a few things about car loans. When a lender makes a car loan, the borrower promises to pay the loan amount plus interest. The borrower also promises to pledge the car as collateral for the loan. This means that if the borrower does not pay as promised, the lender can recover the car and sell it. The lender sometimes recovers the car by politely requesting that the borrower return it. But sometimes, the lender simply sends a tow truck and takes the car - often in the middle of the car.
Theoretically, once the lender recovers the car, the lender sells the car, deducts the loan balance from the sales proceeds, then refunds the balance to the borrower. Realistically, however, the borrower rarely sees any money. Not only do cars depreciate fast, but also, the lender will sell the car at an auction at a ridiculously low price. But that's just the beginning. The lender will also add towing charges, storage charges, auction fees, interest, late fees, and perhaps other fees to the loan balance. The result is that usually, the only thing the borrower will receive is a bill for the balance. This is called a "deficiency claim."
If the borrower does not pay the deficiency bill, the lender has the right to put the account into collections or sue the borrower. And most lenders do exactly that. This means the lender can obtain a judgment for the entire amount, plus, usually, court costs and attorney fees. The unfortunate borrower will eventually have their wages garnished or bank accounts levied - all for a car that they lost a long time ago.
Hypothetical Situations and Options
Let's say that this same hypothetical borrower decides to file chapter 7 bankruptcy before her car is repossessed.
Since the car is collateral, the borrower has four choices. The debtor can either:
- Surrender the car to the bank.
- Pay the lender the value of the car.
- Reaffirm the debt on the car.
- Do none of the above.
Options 1 and 2 are the most straightforward.
If the borrower exercises option 1 and returns the car in chapter 7, the deficiency amount will be wiped out with all of her other debts in bankruptcy. But if the borrower wants to keep the car, this option is not a solution. The second option will give the borrower a chance to keep her car. But few borrowers can afford to redeem their car under option 2. Still, the option is available.
Options 3 and 4 are inter-related. Let's discuss option 3 first.
Reaffirming a debt means the borrower enters into a new agreement to keep the car, and continue paying the car loan, even after she receives her bankruptcy discharge. The borrower may think this is a good arrangement. But reaffirming the debt can have very negative results.
Simply put, if the borrower cannot continue to make the payments after bankruptcy, the lender can repossess the car, and pursue deficiency claim against the debtor. But debtors can obtain chapter 7 relief every eight years. So the debtor may find herself facing collection action, with no relief available.
That's why, at The Fuller Law Firm, PC we rarely advise our clients to sign a reaffirmation agreement. We simply don't want our clients to be exposed to collection activities, lawsuits, wage garnishments or bank levies after they have finished their bankruptcy.
But if a client wants to sign a reaffirmation agreement, the bankruptcy code requires that her attorney review the agreement with her, advise her about the consequences of the agreement, and also make a written opinion as to whether the reaffirmation agreement will cause a financial hardship for the debtor. Then, the reaffirmation agreement must be signed by the bankruptcy judge in order to be effective.
Some of the bankruptcy judges will usually not sign reaffirmation agreements without holding a hearing. If a hearing is held, the debtor, debtor's attorney, and an attorney for the lender will be present. In the hearing, the judge will determine whether the reaffirmation agreement is in the best interest of the debtor. The judge may ask the attorney for the lender to state, on the record, what will happen if the judge disapproves the reaffirmation agreement.
If a reaffirmation agreement is not approved, the lender basically has two choices. It can either allow the debtor to continue to pay the car payments and drive the car. Alternatively, the lender can repossess the car. If the judge asks the lender's attorney to state its intent on the record, most attorneys state that they will let the debtor continue to drive the car so long as she makes the payments.
In most instances, our law firm believes the debtor should not sign a reaffirmation agreement. If the debtor has a car that she wants to keep, we usually advise her to file a chapter 13, where she can stretch her car payments over 5 years, and possibly reduce the interest or principal. And in a chapter 13, if the debtor cannot make her payments, she has several remedies. But if the debtor insists on proceeding to chapter 7, we carefully discuss her situation. Sometimes, she will be able to continue driving her car, make her payments, and not sign a reaffirmation agreement. If you need additional information regarding keeping your car while in bankruptcy protection, and the consequences of reaffirmation agreements, please contact us for a free initial consultation.
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