Reaffirmation: What It Is, How It Works, Example

What Is Reaffirmation?

Reaffirmation is a type of agreement a debtor makes with a lender to repay some or all of a debt despite going through bankruptcy proceedings. When a person files for bankruptcy, they do so in order to be relieved of a debt burden they cannot pay.

By entering into a reaffirmation agreement, a borrower often maintains possession of an asset held as collateral such as a home or a car, so long as they can fully repay the debt owed on that particular loan.

Understanding Reaffirmation

Debtors make reaffirmation agreements purely voluntarily. They are legal documents, but a person cannot go to prison for violating them. If the debtor fails to make their scheduled payments and breaches the agreement, the lender takes possession of the collateral, if they so choose. 

Reaffirmation is not always possible for people filing for bankruptcy. Bankruptcy code stipulates that the debtor's attorney must file a statement with the court affirming that their client can repay the debt without incurring further personal financial harm. Generally, to reaffirm a debt, a person must be current on their payments of that particular loan.

Reaffirmation is primarily utilized in Chapter 7 bankruptcy. Chapter 7 focuses on the liquidation of assets and the order in which the debt is to be repaid. Chapter 7 is primarily used for individuals having difficulty meeting their debt obligations.

Chapter 7 absolves the borrower of the debt that they have to pay, but it does not change the fact that the lender can still seize the assets that are pledged as collateral. Reaffirmation protects against a lender taking possession of your assets.

How Reaffirmation Helps Borrowers

Some borrowers want to continue making their loan payments without going through the formal reaffirmation process. However, reaffirmation has some benefits for the borrower. When a borrower reaffirms a debt, this is noted by credit reporting agencies, which then register that the person is making regular, on-time payments.

This typically helps a person trying to rebuild their credit after bankruptcy. Borrowers who do not reaffirm a debt, however, typically won't see their payments registered with credit reporting agencies. Borrowers who simply need to absolve themselves of their debts and are not likely to make regular payments do not stand to gain anything from the reaffirmation process.

Reaffirmation does make a borrower liable for a debt and is arranged through a formal agreement with the courts, and it is therefore a legal process for the borrower to protect themselves and their assets. It is in the best interest of the borrower to go through a legal process, such as reaffirmation, whenever aiming to resolve or manage financial obligations.

Example of Reaffirmation

Let's say, Alex owns a home and has $200,000 left to pay on their mortgage. Their monthly payments of principal and interest amount to $1,305. Alex recently lost their job during a recession and has been out of work for one year, unable to find employment. They have depleted their savings and are unable to make their mortgage payments.

Alex arranges with their mortgage company a reaffirmation that is approved in court. They reaffirm the debt they owe on the home mortgage, with a chance to renegotiate payments with the lender. They and their mortgage company agree to a lower monthly payment or a lower interest rate during the reaffirmation process. Alex can meet these lower payments with some side jobs they have been able to find.

The reaffirmation has prevented Alex from having to have their home foreclosed. If, however, they fail to make the mortgage payments under the new terms, then the lender will take possession of their home and begin foreclosure proceedings.

The Bottom Line

Reaffirming a debt can jump-start your credit after bankruptcy and let you retain ownership of important assets like a house or car. However, if you're looking for a clean slate, there is no legal obligation to reaffirm your debt. Only you can decide what is suitable for your financial situation.