Bankruptcy can help you wipe out many types of debts—but if the creditor has a lien on your property, you could still lose the property. Why? The discharge—the order that wipes out qualifying debt—doesn't remove liens and liens give creditors property rights. The lien must qualify for removal and if it does, you must ask for its release by filing a motion or lawsuit.
Whether your motion or adversary proceeding (bankruptcy lawsuit) will be successful will depend on:
If you aren't sure which chapter you intend to file, start by learning about the differences between Chapter 7 and Chapter 13).
A valid lien gives a creditor a legal interest in the property. It allows the creditor to claim the asset, sell it, and use the proceeds to pay down the unpaid debt.
In some cases, the debtor agrees to the lien, but not in every circumstance, which is important in bankruptcy. A debtor can't get rid of a voluntary or statutory lien in Chapter 7—only a judgment lien (although a few exceptions exist—more below).
Keep in mind that in most cases, the creditor must perfect the lien by filing documents with the proper government entity. For instance, the Recorder's office where the real estate is located, the Secretary of State, or in accord with your state laws.
Filing for Chapter 7 bankruptcy won't get rid of a lien unless you do more. The lien must qualify for avoidance, and you must file a motion with the court and obtain a court order.
Also, the lien must get in the way of (impair) a bankruptcy exemption—the law that allows you to protect property in bankruptcy. For example, if your state allows you to protect business tools, and a creditor placed an involuntary lien on them, you'd likely be able to avoid the lien.
Here's a list of liens you might be able to remove from your property:
Keep in mind that you can't avoid statutory liens, such as a tax lien (more below), or voluntary liens, such as a mortgage, on your home or your car in Chapter 7 bankruptcy.
Chapter 7 has another way to reduce the amount owed to a lender—redeeming the loan. If you owe more than the value of the collateral, you might be able to reduce the amount owed to the property value. Here are some, but not all, of the conditions:
Debtors with qualifying property usually borrow the funds to pay a lump sum payment from a friend or family. It's also common to use a loan from a lender specializing in these types of loans, but you should anticipate paying at a high-interest rate.
Chapter 13 has two ways that you can avoid liens—through a lien cramdown or lien stripping.
You might be able to reduce the principal balance of some liens through a Chapter 13 cramdown. For instance, using a car loan cramdown, you can reduce your loan balance to the value of the car. But you can also cram down other types of personal property liens as well as rental or investment property liens.
Some of the downsides and conditions include:
Even though you can't cram down a residential property lien, Chapter 13 has a mechanism that can help you lower your home payment. But only if the first mortgage is underwater to the extent that there would be no funds to pay a junior mortgage.
The rule is that you can strip off a wholly unsecured second mortgage or another junior lien on your house, including your principal residence—but only in Chapter 13. Here's how it works.
You'll follow your court's procedure for declaring the junior lien unsecured. For instance, in most courts, you'll need to prove that the junior lien is unsecured through a bankruptcy motion or adversary hearing. If you win, the loan will get paid in the bankruptcy with other general unsecured debts, such as credit card balances and medical bills. Once you complete your Chapter 13 repayment plan and receive the discharge, the creditor must remove its lien from the property.
Example. Suppose that you owe $150,000 on your home's first mortgage and $75,000 on the second. But, because of a down market, if you were to sell the house, you'd only receive $125,000. Because the sales proceeds aren't sufficient to pay off the first mortgage, the second mortgage is wholly unsecured. You could get rid of your second mortgage through lien stripping in Chapter 13. After completing the bankruptcy and obtaining a discharge, the discharge will extinguish the second mortgage, and only the first mortgage lien will remain.
Learn more about removing a second mortgage in Chapter 13.
A debtor can't remove a statutory lien, such as a tax lien, through the bankruptcy process. Only the bankruptcy trustee has the power to avoid a statutory lien, and only if the trustee meets certain conditions.
For instance, the trustee could use the voidable preference power to demand that the IRS return bank account proceeds seized under a tax lien if the seizure occurred within 90 days before bankruptcy. (In re R&T Roofing, 79 B.R. 22 (D. Nev. 1987).)
Handling liens can be a tricky area in bankruptcy. Check with a local bankruptcy attorney to ensure you're protecting your rights.