Second Mortgages in Bankruptcy
In the right circumstances, a Chapter 13 bankruptcy petition can eliminate a second mortgage on your home and eliminate the monthly payment. This procedures is called “Lien Stripping.” Lien stripping is not available in a Chapter 7 bankruptcy.
How Does Lien Stripping Work?
First of all, lien stripping is only available on a second mortgage (or third or fourth, etc.). The Bankruptcy Code prohibits altering a first mortgage on one’s principal residence. If the property is not your principal residence, lien stripping and other options (like cramdown) become available, even on a first mortgage.
Whether lien stripping is available depends on three factors:
(1) the value of your home;
(2) the loan balance of the first mortgage; and
(3) the loan balance of the second (or other) mortgages.
To strip off a second mortgage lien, the second mortgage must be “wholly unsecured.” A second mortgage is wholly unsecured when the home value is less than the loan balance of the first mortgage. For example, if the home is worth $200,000 and the first loan balance is $225,000 and the second mortgage is $40,000, the second mortgage is “wholly unsecured” because the first mortgage has used up all the equity. In these circumstances, the homeowner can discontinue paying the second mortgage; and the $40,000 is re-characterized as unsecured debt and repaid along with all other unsecured creditors. Your plan payment does not go up; you still pay the same disposable income each month into the plan. The second mortgage bank gets a small percentage of the unsecured distribution from the Trustee. And, best of all, if you complete your plan:
- you are discharged from any further responsibility to pay the second mortgage, even if they only get a small fraction of what they were owed through the Plan; and
- the lien is cleared from your title at the Registry of Deeds.
What’s the catch?
No catch. If the fair market value of the home and loan balances are in the correct balance, you are entitled to do this under the Bankruptcy Code. A problem sometimes arises if the home value is too high. For example, if your home is worth $200,000 and the first mortgage balance is only $199,999; then the second mortgage is not “wholly unsecured.” It sounds arbitrary, but even if that second mortgage has only $1.00 of security available, lien stripping is not available. For that reason, we always obtain a qualified appraisal before filing so there are no surprises.
Another current issue on lien stripping concerns the date of valuation. In our Circuit, two judges recently disagreed. Judge Hoffman ruled that the value of your home on the date you file your petition governs whether you can strip a lien or not (In re Sarno); but Judge Boroff ruled the date of your plan confirmation governs (In re Landry). Both judges sit in Worcester, so there is some uncertainty right now.
Do you think lien stripping might help you make your home affordable and valuable again in today’s economy? Use the handy form below, or call 508-485-4500 or contact us for a free initial half hour consultation to see if lien stripping can help you.