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Can I Refinance a Mortgage That Was Discharged in Bankruptcy?

Leon Bayer PhotoASK LEON 

Bankruptcy expert Leon Bayer answers real-life questions.

Dear Leon, 

I filed bankruptcy in 2009. One of the debts discharged in the bankruptcy was a mortgage with Wells Fargo. Upon the advice of my lawyer, I did not reaffirm the mortgage in the bankruptcy. I kept my house, and I have stayed current on my mortgage.

I just asked Wells Fargo to refinance my mortgage at a lower rate. It told me that it cannot refinance the mortgage because I did not affirm the loan in the bankruptcy. It also told me that no bank will refinance the loan, for the same reason.

Should my lawyer have advised me to reaffirm the loan? Is there anything I can do? 

Shirley

 

Dear Shirley,

What Wells Fargo told you is partially right, and partially wrong. If the only issue is that you did not reaffirm the home loan in your bankruptcy, you will be able to refinance your loan with a different lender. Your lawyer was not remiss in advising you not to try to reaffirm the mortgage.

What Is Reaffirmation in Bankruptcy?

Most types of debts are wiped out in Chapter 7 bankruptcy. If you want to keep a particular debt, however, you can reaffirm it. Essentially you sign an agreement with the lender that waives the discharge of the debt. (Learn more about how reaffirmation works in bankruptcy.)

The effect of reaffirming a mortgage is that if you later default on the loan and the lender forecloses, you will be liable for a deficiency (the difference between what you owe and the value of your home). If you don’t reaffirm your mortgage in bankruptcy and later default, the lender cannot go after you for a deficiency. (Learn why reaffirming a mortgage is almost always a bad idea.)

Refinancing a Discharged Loan

If a debt is discharged in bankruptcy, the lender is prohibited from trying to  collect on that debt. The lender cannot sue you, call you, or send you a bill or mortgage statement.

When you refinance a discharged mortgage loan with the same lender who currently holds the mortgage, the proceeds of the refinance go back to that lender to repay the loan balance. This violates the bankruptcy discharge and that’s why Wells Fargo won’t refinance your mortgage. However, this  should not prevent other lenders from refinancing your mortgage.

It’s unfortunate that Wells Fargo was not able to explain the law correctly, or clearly.

Should You Have Reaffirmed Your Mortgage?

But should your lawyer have recommended or tried to get your mortgage reaffirmed? Most likely not.

In bankruptcy, a reaffirmation agreement must be approved by either

  • the bankruptcy judge, or
  • your bankruptcy lawyer.

Bankruptcy court approval. Most bankruptcy judges will not approve mortgage reaffirmations, reasoning that a debtor can keep the house without reaffirming as long as he or she makes timely payments. This makes the reaffirmation an unnecessary liability. Often the only reason in favor of reaffirming is to reestablish a good payment history. (Without a reaffirmation agreement, your future payments probably will not appear on your credit report.) Most bankruptcy judges feel that building future credit is not a sufficient reason to burden a debtor with mortgage liability.

Lawyer approval. If the judge won’t sign off on the reaffirmation, then it won’t be valid unless your lawyer signs a legal declaration stating that the reaffirmed debt will not impose an undue hardship on you or your dependents. Lawyers are very hesitant to sign such a document because they don’t know what their own responsibility will be if you default. Lawyers also reason that if judges won’t sign these agreements, then they shouldn’t either.

The end result: Mortgages are almost never reaffirmed in bankruptcy.

-Leon

Leon Bayer is a Los Angeles bankruptcy attorney.  He is a partner at Bayer, Wishman & Leotta, a California law firm specializing in bankruptcy.  The opinions and advice in this blog post are from Mr. Bayer alone, and should not be attributed to Nolo.  By answering a question on this blog, Mr. Bayer does not become your lawyer.

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10th Circuit Rules: No Tax Discharge in Bankruptcy If You File a Late Return

The 10th Circuit Court of Appeals recently ruled that if a bankruptcy debtor files a “late” income tax return, the underlying income tax debt cannot be discharged in Chapter 7 bankruptcy even if the debtor meets the other criteria for discharging tax debt in bankruptcy.

The Criteria for Discharging Income Taxes in Bankruptcy

Although many income tax debts are not dischargeable in bankruptcy, you can discharge a tax debt if it meets the following criteria:

  • The tax debt is for federal or state income taxes.
  • The tax return was due at least three years ago (this includes all valid extensions).
  • You filed the return at least two years ago.(This is where the “late filed” return issue arises, see below.)
  • The taxes were assessed at least 240 days ago.
  • You did not file a fraudulent frivolous return and you are not evading tax laws.

(To learn more, see Tax Debts in Chapter 7 Bankruptcy.)

The Split in Authority

According to most bankruptcy courts, a late-filed return does not constitute a “return” for purposes of the third prong in the above criteria for discharging tax debt.

What is a late return? Your return is “late” if all of your filing extensions have expired and the IRS has filed a substitute return without your assistance. Your return is not late if the IRS files a substitute return with your assistance under Internal Revenue Code Section 6020(a) — something the IRS may, but is not obligated, to do.

However, some courts have found otherwise:  That a late return is still a “return” for the purposes of the third prong. This means that if you filed a late return at least two years before your bankruptcy and meet the other criteria, you can discharge the underlying tax debt.

The 10th Circuit Decision: In re Mallo

In a recent decision, the 10th Circuit Court of Appeals embraced the first line of authority:  That is, a late filed return does not constitute a “return” for purposes of the bankruptcy dischargeability test. In re Mallo, No. 13-1464, 2014 WL 7360130 (10th Cir. Dec. 29, 2014). The 10th Circuit did say that if the IRS files a return with your assistance under IRC Section 6020(a), then the return does count as a “return” for the third prong of the test.

This case may go to the U.S. Supreme Court; we’ll keep you posted.  In the meantime, if you have income taxes you’d like to discharge in bankruptcy, be sure to speak with a local bankruptcy attorney.

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