With home values flat or even trending downwards in recent months, many Chapter 7 debtors who have been discharged are asking what happens if they stop paying their mortgages and walk away from homes that are worth less than the outstanding mortgage.
If you entered into a reaffirmation agreement during your Chapter 7, you remain liable for the mortgage personally and the lender’s continues to have a first priority lien against the property. If you pack your bags and walk away, your default will negatively affect your credit and you could find yourself liable for a deficiency balance if the lender sues you on the promissory note that accompanies the security instrument (mortgage).
Note that under the Bankruptcy Code debtors have a set time (60 days or prior to discharge, whichever comes later) to cancel their reaffirmation so if your situation changed right after you signed the reaffirmation you do have time to change your mind – talk to your lawyer immediately.
If you did not sign a reaffirmation agreement, I believe that you have a good argument that you have no personal liability if you simply stop paying, pack your bags and move away. In my view, a reaffirmation constitutes a renewal of the promissory note that personally obligates you to pay monthly payments to the lender. If you do not sign a reaffirmation, your bankruptcy discharge serves to eliminate this obligation.
This is why debtors who do not reaffirm their mortgage obligations stop receiving statements from the mortgage lender and why lenders no longer report positive or negative information about mortgage payments on the homeowner’s credit reports.
Note that a Chapter 7 discharge does not eliminate the underlying lien – the property cannot be sold until the mortgage obligation is paid.
I have always found it odd that mortgage lenders are willing to keep mortgage loans on their books when there is no personal liability. I wonder if a homeowner would gain some sort of property right to remain in the property if he paid the mortgage year after year and faced a foreclosure proceeding at some remote point in the future (i.e. 10 years) based not on a delinquency but on a default caused 10 years previously by a bankruptcy filing (if you look at most promissory notes, a bankruptcy filing constitutes a default event).
I am also not seen any case law whereby a discharged Chapter 7 debtor who did not enter into a reaffirmation somehow becomes obligated under an “implied contact” theory – I believe that in most States, obligations arising from real estate transactions must be in writing. A lawyer versed in real estate law in your State would be the appropriate resource to ask as every State has its own real estate and laws of contracts.
If you have received your Chapter 7 discharge and you did not reaffirm your mortgage, and now you want to walk away from a property that you have lived in under an informal “keep and pay” arrangement, you would be wise to speak with your bankruptcy lawyer to ask for advice about possible issues – both as a matter of contract liability and as to your credit.
Jonathan Ginsberg, Esq.
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Last modified: October 22, 2012