Bankruptcy expert Leon Bayer answers real-life questions.
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?
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 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.