As Americans struggle to recover from the recession, many are dealing with the fallout of de-valued homes saddled with costly second mortgages and HELOCs (home equity lines of credit). Various lenders are threatening foreclosure actions or lawsuits to collect payments on these debts. Despite the legal threats and damage to credit scores, homeowners can take solace in bankruptcy protection. Filing for bankruptcy can erase many of these debts while protecting the equity in their homes at the same time.In Chapter 13 bankruptcy, this process is called “lien stripping”, and the explanation is fairly straightforward. Under the U.S. Bankruptcy Code, debt is classified into two categories: secured debt (debt that is attached to a specific asset that a creditor may reclaim if the debt is not paid, such as a car, house or boat) and unsecured debt (debt that is not attached to a specific asset such as credit card debts). Second mortgages, like first mortgages, likely began as a secured debt because it was based on the value of the home at the time it was executed. However, as the home lost value, the second mortgage now becomes unsecured debt because the home no longer has the value to support it.For example, if a buyer purchased a home in 2005 for $450,000, it was likely secured by two mortgages: a first mortgage for $360,000 and a second for $90,000. If the home is now valued at $350,000, the second mortgage is now considered unsecured debt, which can be discharged in bankruptcy while the homeowner still retains the property. This debt now falls into the same category with credit card debts and unsecured personal loans, and can essentially be “stripped” from the property.
One caveat is that this process requires a motion to the court to prove that the value of the home is less than the first mortgage. An appraisal is needed to support the motion, and it should be completed before the required Chapter 13 plan confirmation hearing. If the second mortgage holder disputes the appraisal, an adversarial proceeding may be necessary to prove the actual value of the property.
Nevertheless, lien stripping is a powerful tool to help homeowners in their properties while paying for the true value of the home.
If you have questions about whether additional liens on your property may be discharged through bankruptcy, contact an experienced bankruptcy attorney.