When a debtor files for Chapter 7 bankruptcy protection, all contracts between the debtor and his creditors are rendered “null and void”. A mortgage is a contract between the debtor ( the mortgagor) and the lender (the mortgagee). If the debtor files for bankruptcy and wishes to keep his home, then he must reinstate the mortgage. He does so by signing a document called a reaffirmation agreement.
The reaffirmation agreement is provided by the lender. It does NOT start the mortgage all over again. Rather, it reinstates the mortgage as if the debtor had never filed for bankruptcy in the first place. By signing the reaffirmation agreement, the debtor agrees to continue paying on the mortgage at the same monthly payment, at the same interest rate for however many months remain on the mortgage.
If the debtor wishes to surrender his home, this does not mean that he has to pack his bags and vacate the premises right away. The mortgage lender must start foreclosure proceedings, which typically take about 90 days from initiation to sale date. Once the foreclosure sale happens, the debtor automatically gets another 6 months after the sale before he has to vacate the premises. So the debtor can live in the home “rent free” for at least 9 months. This is a valuable right for the debtor. For example, if the debtor were to start paying rent at the rate of $1,000 per month once he vacates, by living rent free in the property for nine months, he would save $9,000 in rent.
Various factors come into play as to when a debtor should reaffirm a mortgage, or surrender a mortgage. If the debtor has “equity” in the house, then most likely he should reaffirm so as not to lose his equity. Equity is the difference between what the debtor owes on the mortgage and what the house sells for. Sometimes, the debtor might not have any equity, but his mortgage payment is so low that it is cheaper to continue paying the mortgage than to surrender the property and pay rent. Other times, the debtor might have a cheap mortgage payment, but the neighborhood went bad. No matter how cheap the mortgage payment is, if the neighborhood is no longer safe, the debtor may have to move for his safety.
The biggest problem is whether the debtor should reaffirm when he owes significantly more on the mortgage than what the house is worth. If the debtor does NOT reaffirm the mortgage but stays current on the mortgage payment, the mortgage lender will let the debtor continue living in the house. This might seem like the best of both worlds. By not signing the reaffirmation agreement, the debtor could walk away at anytime, stop paying the lender, and have no liability whatsoever to the lender. However, if the debtor later gets his equity back due to property values appreciating, he would not be able to refinance the loan to obtain a better interest rate. He would also not be able to obtain a loan modification if he later falls behind on the mortgage payment but wants to keep the property. These are the potential rights he would lose by not signing a reaffirmation agreement.