Loan modifications take forever or may even get denied for unknown reasons. Meanwhile the credit card bills, medical bills and other obligations become overwhelming. You have a second mortgage or home equity line in excess of the value of your home, and your home is underwater on your first mortgage. A Chapter 13 bankruptcy may allow you eliminate or “strip” your second mortgage or home equity line of credit.
A lien strip allows a Chapter 13 debtor to use the Bankruptcy Court to transform a secured second mortgage or home equity line of credit into an unsecured debt, thereby eliminating a monthly payment and reducing total debt by a great amount.
I recently read a story about a family in Sacramento that bought their house for $250,000 3 years ago and now a similar house is selling for $80,000 in their neighborhood. This isn’t an unfamiliar tale in during this economic downturn. Therefore, say their home is worth $100,000. Assume they have a first mortgage of $150,000 and a second for $50,000. Their debts have become overwhelming and they explore the option of filing for bankruptcy.
In this case, the family could ask the bankruptcy judge to “strip away” the second mortgage debt since all of the value in the home is encumbered by the first mortgage. If the first lender were to foreclose, if bankruptcy was not filed, the second lender’s lien would be wiped out. As such, the second lender is unsecured. The Bankruptcy Code applies the same logic and allows a judge to strip the de facto unsecured lien.
Lien stripping only works when:
- you are a debtor in a Chapter 13 case
- the fair market value of your house is less than the balance due on your first mortgage
Now, if you’re the lender on the second mortgage or HELOC you’re going to vigorously oppose any such motion to make your lien unsecured. The main tactic for the second lender would be to get a high valuation of the property. So the debtor will have to, more than likely, pay for an appraisal of the property because no doubt the lender will come in with a high appraisal.
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