When you take a mortgage loan, you have to sign two types of legal contracts: a promissory note and a collateral pledge. In a promissory note, you make a promise to pay the money you borrowed. In the second agreement your obligation creates a property lien, whereby you pledge your property as loan collateral.
If you file for bankruptcy, you will receive a debt discharge by the end of the case. If you do not reaffirm your mortgage debt, your obligations to pay it off will be wiped out. . But a Chapter 7 discharge will not remove the mortgage lender’s lien against the secured property. You may want to reaffirm the mortgage loan if you want to keep the property. To “reaffirm” a mortgage means that you are in fact reaffirming the promissory note and your personal obligations to make the payments.
However, there are some homeowners who choose not to enter any reaffirmation agreement for mortgage loan, auto financing, or any type of secured debt. This is because even without a personal assurance by the borrowers, mortgage companies are sure to get the secured property. If the lender will accept your payments, you would be able to the property. But if you miss the payments, the mortgage lender may repossess or foreclose based on the lien. You will not have any liability on any repossession or foreclosure deficiency for the reason that your personal obligation was removed in the bankruptcy discharge.
Although this may seem like a good idea, there are disadvantages of not reaffirming a debt while continuing the payments, also known as “pay and stay”. First, you are not getting any positive credit report for making the mortgage payments. The mortgage lender will no longer report anything because your personal obligations were already discharged in bankruptcy. A good payment record from a mortgage lender can be a great way to rebuild credit after bankruptcy.
Second is the uncertainty factor. Most loan payment notes comprise a default provision including filing of a bankruptcy petition as a default trigger. In theory, when a bankruptcy case is concluded, a mortgage lender can assert a loan in default. Since the automatic stay would be terminated after a bankruptcy, the lender can take a legal action to acquire the collateral. However, lenders often want to get the monthly payments rather than the collateral. In this case, you would have to risk without a debt reaffirmation.
Lastly, you will not be able to negotiate better terms for a mortgage in a pay and stay. A reaffirmation agreement will allow you to get lower payments and interest rates.
In most cases, mortgage companies would rather take the monthly payments rather than proceed with a foreclosure. Some would even offer to refinance the outstanding balance and reduce the balance. On the other hand, there are also mortgage lenders who will not agree to a reaffirmation - some do not enter into reaffirmation agreements in spite of an attorney’s best efforts.