CAN I GET RID OF MY SECOND MORTGAGE IF I FILE BANKRUPTCY?
Because of the decline in property values over the past few years, there has been a lot of discussion about “lien stripping” of second mortgages. Lien stripping means taking a debt that is secured by a mortgage and converting it to an unsecured debt or quite literally, stripping the mortgage off. This post will discuss the circumstance in which this relief is available through bankruptcy.
It is generally understood that consensual mortgages or deeds of trust on real estate that is one’s principal residence cannot be eliminated through bankruptcy. This is true regardless of whether one files a Chapter 7 or Chapter 13 bankruptcy. In fact, these types of mortgages cannot be modified in any way. By filing Chapter 13, one can take up to five years to make up missed payments, but the amount of the monthly payment, the principal balance and the interest rate cannot be altered.
There is, however, an exception to this axiom for what are referred to as completely “underwater” or “unsecured” mortgages. These are mortgages in which there is no equity whatsoever available to secure this second mortgage. This will be the case when the amount owed on the first mortgage exceeds the fair market value of the property. For example, the property in question has a fair market value of $100,00.00 and the balance owed on the first mortgage is $110,000.00. Since the first mortgage would get paid in full at foreclosure before any money gets paid on the second mortgage, this scenario leaves the second mortgage as essentially unsecured, opening the door for that second mortgage to be stripped off.
Motions to strip off second mortgages can only be brought in Chapter 13 cases. Chapter 13 is available for wage earners and other individuals who have regular monthly income. If the second mortgage meets the criteria set forth above, then it is eligible to be stripped off in Chapter 13. This means that the debt, instead of being treated as a secured debt, will be treated as unsecured. This is extremely important because in Chapter 13 secured debts must be paid in full with interest over no longer than five years, whereas unsecured debts can oftentimes be paid only a percentage and with no interest. The percentage of unsecured debt that must be paid will depend on the individual’s disposable income and various other factors, but being able to treat that second mortgage debt as an unsecured debt will be a huge advantage for the debtor in bankruptcy.
In order for this to work, it is important that the debtor have a recent appraisal of the property in question. The creditor whose mortgage is being eliminated will certainly not be happy and will not take the debtor’s word for it when it comes to value. Furthermore, the creditor has a right to object to the motion to strip off the mortgage if it disagrees with the debtor’s valuation of the property. In that case, the matter will go in front of a judge, who will decide what the property is worth after hearing evidence from both sides.
This type of relief is available only in Chapter 13, not in Chapter 7. If one files Chapter 7, the second mortgage cannot be eliminated, so if the debtor cannot afford to pay both the first and second mortgages in the full amount, then the property will have to be surrendered. Whereas, in a Chapter 13, under the right circumstances, that second mortgage may be able to be converted to an unsecured debt and satisfied for pennies on the dollar. So if you have a second mortgage, don’t always assume that Chapter 7 is your better option. Consult with an experienced attorney in order to learn what your best options are.