In my last two blogs, I’ve written about some unexpected consequences that some of our clients experience as a result of filing a bankruptcy case. These surprises come from different areas - from the fact that ACH payments can be discontinued to the fact that a lapsed car insurance policy can result in a safe driver being dropped into the risk pool when a new auto-owners policy is taken out. This week I’ll continue to write about expecting the unexpected as a result of filing a bankruptcy case.
You may not get credit on your credit report for making timely mortgage and/or auto loan payments
It is extremely common for people who are facing significant financial difficulty to, despite financial pressure on their household budgets, to religiously make timely payments on their home mortgage and car loan payments. So much of our financial behavior is based on choice-making, and for many people, keeping their home and car are high priorities. So payments get made, on time, for these secured loans before a bankruptcy case is filed - and in most cases, these payments continue being made, on time, after the bankruptcy case is filed.
So the client who has weathered the financial storm, and made timely payments on secured debts despite financial difficulties should see a benefit in credit reporting, right?
Well, that used to be the case, but, increasingly, many bankruptcy debtors find out that the timely payments they have been making on secured loans is not showing up on credit reports. Instead, the creditor is reporting the loan as “in bankruptcy.” When bankruptcy debtors are back up on their financial feet, and are now applying for a car loan or mortgage refinance, many are finding difficulty getting loans approved because there is no record of the bankruptcy debtor/loan applicant making payments on an existing loan.
Why are the lenders doing this?
It has to do with reaffirmation agreements - the legally binding agreement to reinstate a bankruptcy debtor’s personal liability on a loan. Secured lenders such as mortgage lenders or auto loan lenders want bankruptcy debtors to sign reaffirmation agreements. The lawyers representing bankruptcy debtors - the professional whose obligation it is to look after their clients’s best interests - will in almost all cases advise clients to not sign reaffirmation agreements, due to the reinstatement of personal liability when reaffirmation agreements are filed with the bankruptcy court.
Since the loan is, in many cases, not being reaffirmed, most, but not all mortgage lenders and some, but not all auto loan lenders don’t report timely payments. The credit entry coming from the creditor will only show current payments if a reaffirmation agreement is signed and filed with the court. Despite this, most bankruptcy practitioners (this one included) advise clients to not sign reaffirmation agreements under any circumstance.
So what’s a potential borrower who is a former bankruptcy debtor to do when the borrower needs to borrow money for a car purchase or needs to refinance a home mortgage? First, don’t sign the reaffirmation agreement. The credit-reporting benefit does not outweigh the risk that a debtor may default on the reaffirmed loan, which will then lead to the secured creditor repossessing loan collateral and assessing a deficiency against the borrower if the auction proceeds after the collateral is sold does not pay the loan balance.
Instead of signing a reaffirmation agreement, the borrower has a simpler, and less financially risky option: request a payment history from the creditor reporting the loan as “in bankruptcy.” If requested, the lender has to supply the borrower with the lender’s account record of the loan, including the payments made before and after the bankruptcy case was filed.
This isn’t a fool-proof solution, since the borrower’s credit score might take a hit from the “in bankruptcy” notation. But if a prospective lender is nervous about closing a loan due to the credit report notation, showing the lender a record of timely payments will often do the trick to approve a former bankruptcy debtor’s loan.
That’s enough for this week. Next week we’ll have a few more surprises in store.