Chapter 13 bankruptcy provides homeowners with a number of tools they can use to avoid losing their homes to foreclosure. One of those tools is a process called lien stripping, which has the power to eliminate second and third mortgages, which can significantly reduce what homeowners owe and make their homes more affordable again. Here's more information about how this procedure works.
Only Underwater Homes are Eligible
Lien stripping essentially turns a secured debt (e.g. second and third mortgage) into unsecured debt that can be discharged when the chapter 13 case ends. This has to do with how the mortgages are prioritized in foreclosure cases. The first mortgage you acquire always receives first consideration in any legal situation. Thus, in foreclosure or bankruptcy, it will be paid first. Any other mortgages will be paid in the order acquired if there are any funds left over from paying off the first mortgage.
If there's isn't enough value in the house to pay off all the mortgages attached to it when the property is sold, those mortgages that were acquired after the first one will essentially be considered unsecured, because there isn't anything left on the home to secure the loan.
For example, the balance of your first mortgage is $200,000 while the second is $100,000. If the value of the home is $350,000, then both mortgages will remain attached to the home because the market value is high enough to cover them if the home is sold. On the other hand, if the home's value dropped to $175,000, only the first mortgage would be covered, since there's no longer any equity available to cover the second mortgage.
As a result, the bankruptcy court will order the lenders for your second (and any subsequent mortgages not covered by the home's value) to remove the lien to the home. Those loans would essentially be considered unsecured and treated accordingly.
Be aware, though, that this doesn't happen automatically. You must either submit a motion or file an adversarial proceeding to the court to have the liens stripped from the home. Additionally, the liens will only be removed and the debts discharged upon completion of your chapter 13 plan. If your case is dismissed or you fail to complete the plan as agreed, the lien stripping request will be rejected and you'll be responsible for paying the mortgages that would've been abolished.
Creditors Can Still Object
If you have a home that's underwater in the mortgages, lien stripping is an excellent way to get rid of some of the debt and make your monthly payments more manageable. However, mortgage creditors generally won't go down without a fight. If there's any chance the creditor can successfully object to the lien stripping, you can be sure the creditor will take advantage of it.
There are a couple of claims the creditor can use to counter your request to strip the lien. The company may claim you received the loan using fraudulent methods. For instance, if you misrepresented your income on your application, the creditor may use that to show you obtained the loan under false pretenses. If the court accepts the creditor's argument, the lien and the associated financial responsibility will remain in place.
Another thing the creditor may do is dispute the valuation of the home. It may obtain an appraisal to show the home is worth more than you claim or present evidence the valuation was tainted or incorrect in some way. You may be required to obtain another appraisal to confirm the market value of your home as a result. If the creditor is successful, the court may either adjust how much you owe on the second mortgage (e.g. if the valuation shows the home is worth $25,000 more than previously thought, you may be ordered to pay that amount) or reject your petition altogether.
Stripping a second and third mortgage from a home using bankruptcy can be challenging. It's best to consult with an attorney for advice and assistance with this issue. Click here, or on similar sites, for more information.