More frequently than ever mortgage lenders are asking Chapter 7 bankruptcy debtors to sign reaffirmation agreements. A reaffirmation agreement, if signed by the debtor’s bankruptcy attorney or approved by a bankruptcy judge, reinstates your personal liability on a debt. On the other hand, when a debt is not reaffirmed, your personal liability goes away upon receiving a bankruptcy discharge.
What is the difference from a practical standpoint? Generally speaking, when you have personal liability on a secured debt, such as an auto loan or a mortgage, should you fall behind on payments the lender can not only repossess a car or foreclose on a house, it can also collect any deficiency balance from you personally. This can lead to a lawsuit and collection on a judgment through actions like wage or bank account garnishment. Of course, that’s the last thing you want to have to deal with after going through the bankruptcy process.
But it’s a little more complicated than that when it comes to reaffirming a mortgage in Arizona. This is because Arizona has a law commonly known as an “anti-deficiency statute”, which protects residential borrowers who meet certain conditions. When protected by the anti-deficiency statute, Arizona homeowners are essentially free to stop making payments and walk away from the property without having to worry about the lender coming after them for payment of the debt.
To qualify for anti-deficiency protection, the mortgage must have been given to secure the payment of the balance of the purchase, or to secure a loan to pay all or part of the purchase price (commonly referred to as a “purchase money mortgage”). There is no protection for mortgages securing loans used for something other than the purchase of the property, such as a home equity loan used to pay off credit card debt or make improvements to the property. Similarly, if the original mortgage has been refinanced with equity cashed out, as opposed to a streamlined refinancing of only the remaining portion of the original loan amount, the lender does have recourse against you. There is another requirement for anti-deficiency protection, which is the property securing the loan must be (1) two and one-half acres or less, and (2) limited to and utilized for a single one-family or single two-family dwelling.
Should you meet the above requirements under Arizona’s anti-deficiency statute, there is no downside to reaffirming a mortgage because the lender doesn’t have recourse against you personally anyway. The upside to reaffirming is the lender will report your payment history to the credit bureaus, whereas that otherwise stops when you file bankruptcy. However, it is generally not advisable to reaffirm a mortgage that does not meet the requirements for anti-deficiency protection. Even if the property currently has enough equity to sell it and satisfy the mortgage should you become unable to make payments, that can change with a decline in real estate values.