If your home value has gone down a lot, you may be able to turn that bad news into good news. If you have a second mortgage, AND if your home is now worth less than the amount of your first mortgage, then with the help of the bankruptcy laws you may well be able to write off your second mortgage and stop making payments on it. That mortgage could be "stripped off" your home’s title permanently. This could save you tens of thousands, or even hundreds of thousands, of dollars.
Can Only be Done through Chapter 13
The power to get rid of a mortgage is highly unusual in bankruptcy. That’s because the law generally treats mortgages quite favorably, supposedly for the purpose of protecting the mortgage markets. The theory is that homeowners’ obligations on mortgage loans should not be able to be significantly changed through bankruptcy or else investors would be discouraged from putting money into mortgage loans.
So stripping a second mortgage is NOT available under Chapter 7, the "straight bankruptcy," but instead only under Chapter 13, the partial-payment type of bankruptcy. Because a Chapter 13 usually takes three to five years of monthly payments into a court-approved “Plan” to finish, it is a much more involved option. It is not always worthwhile. That depends on all the circumstances. But if filing a Chapter 13 case would result in getting rid of the second mortgage lien and paying nothing or very little of the underlying debt, that would be a major reason to consider this option very seriously.
Learn more about Chapter 7 and Chapter 13 Bankruptcy in the Bankruptcy Information section.
Only Available if No Equity Protects the Second Mortgage
A second mortgage can only be "stripped" off a home's title if that home is worth LESS THAN the amount of the first mortgage PLUS any other liens against the house that come legally ahead of that second mortgage. (Liens that sometimes come ahead of second mortgages include ones involving property taxes, homeowner association dues, and sometimes judgments and income tax liens.) In other words, all of the equity in the house must be exhausted by those "prior" liens, leaving nothing whatsoever for the second mortgage. If any equity at all is left over for the second mortgage—even just a few dollars worth—the mortgage-stripping cannot be done. This is a strict all-or-nothing rule.
Two Examples:
Here’s an example to illustrate when a second mortgage can’t be stripped:
$260,000 Value of Home
-$5,000 Unpaid Real Property Taxes owed
-$250,000 First Mortgage
$5,000 Amount of Equity in Home for 2nd< Mortgage
$30,000 Second Mortgage
Even though there is only $5,000 in equity for the $30,000 second mortgage, it cannot be stripped off in a Chapter 13 case.
And here’s an example to illustrate when a second mortgage can be stripped:
$250,000 Value of Home
-$5,000 Unpaid Real Property Taxes owed
-$247,500 First Mortgage
($2,500) Negative Equity in Home for 2nd Mortgage
$30,000 Second Mortgage
Because there is no equity at all in the home for the $30,000 second mortgage, it can be stripped off.
Second Mortgage Stripping Procedure
Assuming that your home appears to qualify for stripping the second mortgage, your attorney will need to initiate a special procedure in the bankruptcy court in order to accomplish this. Notice that whether or not there is any equity for the second mortgage depends in large part on the value of the home. The second mortgage holder—which of course does not want its lien stripped—may try to argue that the home is worth more and that therefore it is protected by some equity. The court will then likely need evidence—in the form of an appraisal or the testimony of an appraiser—about the home’s value. With or without objection, if the court is convinced that the second mortgage has no equity protecting it, the court will enter an order stripping off the lien.
Payments on Second Mortgage During Chapter 13 Case
The stripping of the second mortgage from the home’s title converts the debt owed on that second mortgage from a secured debt to an unsecured one. It turns from a debt secured by your real estate to one secured by nothing. As a result, that mortgage balance is put into the same pot as the debtor’s other regular unsecured debts. Those are other debts which have no collateral attached to them, such as most credit cards and medical debts. In many situations that does not increase what you have to pay into your Chapter 13 Plan before it is completed. That’s because often the debtor is already paying all that he or she can afford to pay, and putting more debt into that unsecured pot does not increase what the debtor can or should pay. And even if the debtor does have to pay something more, almost always it’s only pennies on the dollar. In either case, at the end of the Chapter 13 case the debtor owns the home completely free and clear of that second mortgage.
Learn more about mortgages and liens in bankruptcy in our section on Your Home in Bankruptcy.
