Can You Refuse to Reaffirm a Second Mortgage During Bankruptcy?

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Although you've filed for bankruptcy, it is still possible to keep your home despite having a second mortgage on the property. If you filed Chapter 7, you can enter into a reaffirmation agreement with the lender. By doing so, you agree to remain liable for debts secured by the property. However, you have to stay current and continue making payments. If you don't, you won't be able to discharge this obligation in the future, and the lender can come after you for the balance of the debt. If you have the chance to reaffirm a second mortgage and refuse, you may lose your home, although most mortgage lenders will let you stay without one as long as you keep paying the bill.

In a Chapter 13 case, there is no reaffirmation agreement; however, you must treat the mortgage in your repayment plan if you want to keep the property.

Secured vs. Unsecured Debts

Secured debts are those for which a creditor has secured a right in a debtor's property through a lien, as in the case of a car or home loan. The property being secured is often referred to as collateral.

The creditor's security interest in the property ensures payment of the debt, so if the debtor fails to make payments as agreed, the creditor can take the property. For example, failure to make payments on a mortgage or car loan results in the foreclosure of the home or repossession of the vehicle. In contrast, unsecured debts, such as credit cards and personal loans, are not secured by any property.

Second Mortgage

A second mortgage, or junior lien, is a loan you take out on your property while the original loan, or primary mortgage, is still in place. Common examples include home equity lines of credit and home equity loans. As with the first loan, the home serves as collateral, making the second mortgage a secured debt.

In the context of bankruptcy, your second mortgage holds a secondary, or subordinate, position to your first mortgage. This means that if your home is foreclosed upon and sold at a sheriff sale, the original mortgage lender receives payment first. In the event there are not enough funds to pay both mortgages, some or all of the second mortgage may go unpaid. In other words, it will be treated as an unsecured debt.

Chapter 7 vs. Chapter 13

If you fall behind on your second mortgage payments, you might file either Chapter 7 or Chapter 13 bankruptcy. Chapter 7 bankruptcy requires you to give up all of your nonexempt assets to pay your creditors. On the other hand, Chapter 13 lets you hold on to your assets; you enter into a repayment plan and pay some or all of your debts over a three- to five-year period.

Chapter 13 requires all secured debts to be paid by the plan unless you're surrendering the collateral. If you are behind on your second mortgage, you would be required to bring this loan current before you receive a discharge at the end of the repayment plan.

However, if your first mortgage is underwater (the property is worth less than you owe on it), the second mortgage can be "stripped" by the court, meaning it will be turned into an unsecured debt, and you may not be required to pay it in full, or at all, as long as you complete your Chapter 13 plan.

Read More: Chapter 7 Vs. Chapter 11 for Individuals

Reaffirmation Agreements

If you want to keep your home despite filing for bankruptcy, you have two options available to you: you can either surrender the property or agree to repay the mortgage and keep it (unless you're stripping it off in Chapter 13).

In Chapter 7 cases, secured debts may be reaffirmed. Reaffirmation of a loan, a legally binding agreement, allows you to waive the right to discharge the debt in bankruptcy by promising to pay the debt.

Not all creditors accept reaffirmation, especially if you are badly in arrears. With a reaffirmation agreement in place, however, you continue to make mortgage payments during the bankruptcy and after. If you subsequently fall behind, you will not be able to discharge this debt, and when the lender forecloses, if the sale of the house isn't enough to pay the debt, the lender could go after you for the difference (the deficiency balance).

If you do not reaffirm the debt but keep paying the mortgage, the lender may allow you to keep the property anyway. If you default down the road, the lender can foreclose, but you will not be liable for any deficiency balance.

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