Non-Recourse Debts After Bankruptcy

During Chapter 7 bankruptcy, the debtor is obligated to file a statement with the bankruptcy court that gives the debtor’s intention concerning secured debts. The choices on this statement of intention are: (1) surrender the property back to the creditor; (2) redeem the property by paying its fair market value in a lump sum; (3) reaffirming the debt; or (4) “other,” which usually means avoiding a non-possessory, non-purchase money security interest. What Congress and the banks do not want the debtor to do is to keep the property and discharge the personal liability.

A loan that is secured by property, but the debtor is not personally liable, is called a “non-recourse debt.” Non-recourse debts can arise during bankruptcy when a Chapter 7 debtor keeps secured property and continues to pay the debt, but does not execute a reaffirmation agreement with the creditor. The personal obligation to pay the debt is discharged by the bankruptcy. This is especially useful in automobile situations because the debtor gets to drive his car until it dies, then walk away without personal liability. A great deal of litigation has been fought over whether the creditor can repossess the collateral if the debtor has continued timely payments, but discharged the personal liability in bankruptcy. The law is still evolving in this area. A non-recourse loan situation is a “have your cake and eat it too” situation. Generally these types of loopholes are closed over time, especially when they hurt banks and favor consumers.

Discharging mortgage liability is one application of the non-recourse loan that is currently popular. By discharging the personal obligation on a mortgage note, the debtor gets to continue his or her ownership, but can walk away at any time without recourse. Since the debt was discharged in bankruptcy, the personal debt is wiped clean and should not show up on a credit report. This can be a mixed blessing. Home ownership and a stellar payment history can significantly aid in rebuilding credit.

Whether you should discharge a secured debt and continue to pay for the property after your Chapter 7 bankruptcy is a difficult decision that should be discussed with your attorney. An experienced bankruptcy attorney can help you weigh the pros and cons of converting your secured loan into a non-recourse loan without harming you in the long term.