Lien Stripping

Can I Get Rid of My Second Mortgage through a Chapter 13 Bankruptcy?

Technically, a mortgage is a lien on your property that is held by the lender. The Bankruptcy Code allows you to “strip away” liens when the value of the property is low enough so that creditor wouldn’t get anything if they foreclosed. Then, the “stripped lien” is treated like other unsecured claims (like credit cards). Part of the original amount will be paid back through the Chapter 13 plan, but this amount is usually pennies on the dollar. After the plan is completed (in either 3 or 5 years), a Federal Court order is issued directing the lender to officially remove the mortgage from the title of the property.

Here is an example of how it all works:

Joe owns a home that was worth $650k when he bought it. There is a first mortgage for $400k and a second mortgage for $200k. Due to the housing market collapse, Joe’s home is now only valued at $395k. Joe can use a Chapter 13 Bankruptcy to “strip away” the 2nd mortgage.

The reasoning: If Joe stops paying on the second mortgage and the lender forecloses, there will be no money from the sale to go to pay off the second mortgage. (This is because the first mortgage will get paid first, and there will be nothing left for the second).

The problem: If the value of Joe’s home starts increasing before he files Chapter 13 Bankruptcy, Joe won’t be able to “strip” the second mortgage once the home’s value exceeds the amount of the second mortgage.

The whole story: The second mortgage doesn’t magically disappear. It is treated like any other unsecured debt (like credit cards), and part of it will be paid through the Chapter 13 payment plan. But once the plan has been completed in either 3 or 5 years, the second mortgage is officially and permanently erased, along with all the other unsecured debt. In reality, Joe will be in a much better financial situation in 5 years because he will have literally paid off his second mortgage (or the equivalent) and all of his credit card debt.