Mortgage Lien Stripping in Bankruptcy

by Hermin Dowe on December 24, 2012

Is there a second mortgage or equity line of credit on your house?

Chapter 13 bankruptcy permits “lien stripping” – the removal of a second mortgage or home equity line of credit from your principal residence (under certain circumstances). For example, suppose that your principal residence has a current fair market value of $450,000. The first mortgage has a balance of $500,000 and the second mortgage has a balance of $150,000. Because the second mortgage does not attach to any equity in the property, the lien can be "stripped" in a Chapter 13 bankruptcy, thereby removing that balance of $150,000 upon completion of the repayment plan.

For lien stripping to be beneficial to you, the residence must be your principal residence, i.e., where you sleep at night, and have one to four units. It is important that you really want to stay in this house and that the balance on the second lien is large enough to make a Chapter 13 bankruptcy advantageous.  You don't want to file bankruptcy just to avoid a lien of $10,000.

If a Chapter 13 bankruptcy sounds like something that might work for you, there are several other issues to consider. We must be prepared to prove that your real property is not worth more than the payoff balance on the first mortgage.  As a bankruptcy attorney, I encounter many clients whose homes are jointly held with a family member such as a parent or sibling. In such cases, lien stripping is not allowed unless all parties file separate Chapter 13 cases.

The best scenario for lien stripping is where the first mortgage is a 30-year fixed loan that you can really afford, or a mortgage that has been modified so that you can afford it. If the senior mortgage is going to reset (“balloon”) to a payment that you cannot afford in a few years, there is no reason to spend the money to strip a second mortgage and then lose the house to a foreclosure by the first mortgage lender later.

Lien stripping isn’t the only mortgage-related advantage of filing for bankruptcy under Chapter 13. Frequently, after filing under Chapter 13, you will find the banks more open to discussing a modification of your first loan.

With most of our homes losing equity and now being worth less than the first mortgage, i.e., being “underwater,” there has never been a better time for lien stripping under Chapter 13. Home values are at an all-time low and the number of subordinate liens that do not attach to any equity is at an all-time high. This is truly the icing on the cake if you want to stay in your current residence and meet the other requirements of a Chapter 13 case. Instead of simply walking away from your current residence, it may be a good idea to consider filing for bankruptcy under Chapter 13 and see what it can do for you. Give the Dowe Law Firm a call at 510-233-7700 to see how I can help you.

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