In Chapter 13 bankruptcy, some homeowners may be able to get rid of a second mortgage or home equity line of credit (HELOC) in certain circumstances. This is often referred to as “lien stripping.”
With the decline in the real estate market over the past few years, many homeowners owe more on their homes than their houses are worth. This mortgage deficiency may be the cause of a foreclosure or short sale, and the homeowner may be liable to pay this deficiency back to the lender. If the value of your house has gone done substantially and you have a second mortgage or a HELOC, a Chapter 13 bankruptcy may enable you remove this lien from your home and reduce the amount that you owe.
In order to remove or strip down a second mortgage or HELOC, the value of your home must have declined enough so that the loan or HELOC is no longer secured by your equity in the home. You can demonstrate this by getting a professional appraisal of your home before you file bankruptcy. The appraisal must show that the fair market value of your house is so low that if your house were sold there would not be enough money after paying the first mortgage to pay anything to the second mortgage holder.
Example: Your balance on your first mortgage is $500,000. You have a second mortgage in the amount of $50,000. Your home is currently worth $475,000. In this scenario, your second mortgage is no longer secured by the equity in your home, only $475,000 of the first mortgage is secured by your equity. Because the second mortgage is no longer secured, you can strip it off.
You cannot strip off a second mortgage that is partially secured by your equity in the home. This means that if the value of your house is enough that even part of your second mortgage would be paid out of a sale, it is partially secured and the second mortgage cannot be removed through bankruptcy.
Example: Your balance on your first mortgage is $500,000. You have a second mortgage in the amount of $50,000. The current market value of your home is $525,000. In this scenario, your second mortgage is secured in the amount of $25,000. This is because your home value ($525,000) minus the balance of your first mortgage ($500,000) leaves you with $25,000 in equity, which secures part of your second mortgage. You will not be able to strip off the second mortgage.
Courts do not all agree on the proper method for stripping a lien from your home. Most courts prefer debtors to address the lien stripping and their Chapter 13 plan or to bring a motion asking the court to strip the lien. A few courts require debtors to bring an adversary proceeding in order to strip off a lien. If you file a motion or raise the issue in your plan, and the lender objects, the court will schedule a hearing where you and the creditor can present evidence.
If there is only a small difference between the market value of your home and your first mortgage, you may need to have a second appraisal or present additional evidence to prove the current market value of your house and that the second mortgage is wholly unsecured. The burden of proof is on you.
If the judge rules in your favor, the lien secured by the second mortgage will be removed from your home, and the loan amount will become part of your unsecured debt, and paid along with your other unsecured debt according to your Chapter 13 plan.