In Chapter 13 bankruptcy, some homeowners can get rid of a second mortgage or home equity line of credit (HELOC) in a procedure known as “lien stripping.” Keep in mind that lien stripping was more common during the foreclosure crisis when the real estate market was in decline. Equity has increased, however, and fewer homeowners qualify for lien stripping.
But, your loan might still qualify.
If the value of your house has gone down substantially and you have a second mortgage or a HELOC, a Chapter 13 bankruptcy might allow you to remove this lien from your home, discharge the junior mortgage, and reduce the amount that you owe.
Find out some of the differences between Chapter 7 and Chapter 13.
Before removing or stripping down a junior mortgage or HELOC, the value of your home must have declined enough so that your home equity is insufficient to cover any portion of the loan or HELOC. You can demonstrate this by getting a professional home appraisal before you file bankruptcy. The appraisal must show that the fair market value of your house is so low that if, after selling the house and paying the first mortgage, nothing would remain to pay the second or lesser mortgage holder.
Example. Your balance on your first mortgage is $500,000. You have a $50,000 second mortgage. Your home is currently worth $475,000. In this scenario, the equity doesn’t secure your second mortgage. Why? Because the equity won’t cover the first mortgage in its entirety—only $475,000 of it—leaving the second mortgage wholly unsecured. You can strip it off.
You cannot strip off a second mortgage that is partially secured by your equity in the home. If the value of your house is enough to pay even part of your second mortgage out of a sale, it is partially secured, and the court won’t remove the second mortgage through bankruptcy.
Example. Your balance on your first mortgage is $500,000. You have a $50,000 second, and the current market value of your home is $525,000. In this scenario, $25,000 secures your second mortgage. Here’s the math: Your home value of $525,000 minus the balance of your first $500,00 mortgage leaves you with $25,000 in equity partially securing your second mortgage. You won’t be able to strip off the second mortgage.
Not all courts 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 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 might 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 court will remove the lien secured by the second mortgage 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.