When you file bankruptcy under Chapter 7, you can’t get rid of second mortgages, HELOCs (Home Equity Lines of Credit) or home equity loans. Nonetheless, due to few bankruptcy cases coming out of the Eleventh Circuit Court of Appeals, you might be able to eliminate these liens through Chapter 7. Repaying debts through court intervention is indeed a common way for homeowners to walk away from their secured as well as unsecured debt and give a fresh new start to their lives. While there’s nothing wrong with that, it doesn’t always have to be that way. It’s possible to file bankruptcy and retain your home.
Scenario:
Suppose your house is worth $250,000. You owe $300,000 on your first mortgage and $150,000 on your second mortgage. In short, the amount that you owe on your first mortgage loan is greater than the present valuation of your home. Under the current existing law, if you’re a resident of Florida, Alabama or Georgia , you can retain your homeownership rights in the bankruptcy case and then eliminate the second mortgage. Once you get a discharge, just like all your other debts, your second mortgage debt vanishes. The first mortgage still remains and you’re liable to pay that amount ($300,000).
Lien stripping - What is it?
Lien stripping is a powerful tool that is available in Chapter 13 and even in Chapter 7 bankruptcy. You’re allowed to let go of your junior liens only when they’re entirely unsecured. What is the meaning of this?
A junior lien is anything apart from your first mortgage loan and hence loans like home equity lines of credit (HELOC), home equity loans (HEL), second and third mortgages would be included.
A lien is entirely unsecured when the equity in the property doesn’t cover any of the lien amount. For instance, if your home is worth $200,000, your first mortgage loan amount is $250,000 and second mortgage is $50,000. Since the amount on your first mortgage is more than the equity in your home, there’s practically no equity left to cover the second mortgage loan or the junior lien. So, if the lender had to foreclose your home, the first mortgage lender would receive $200,000 and the second mortgage lender wouldn’t receive anything.
If the home equity loan or the junior mortgage qualifies for lien stripping, the debt which was formerly secured, becomes unsecured.
When can you strip your liens and second mortgages in Chapter 7 bankruptcy?
Stripping off your junior liens in Chapter 7 bankruptcy wasn’t possible in most bankruptcy jurisdictions but according to the decision of the Eleventh Circuit Court of Appeals, lien stripping is now available in Chapter 7 as long as none of the lien is secured. If it’s possible to remove a secondary lien in Chapter 7 bankruptcy, the amount of the lien then becomes a part of your unsecured debt and in most cases it’s discharged off later.
States in the Eleventh Circuit include Florida, Alabama and Georgia and this means that if you’re a resident of any of the aforementioned states and you’re filing for bankruptcy, you might be able to strip off the junior liens under the Chapter 7 case. However, whether or not you can eliminate the junior liens in Chapter 7 bankruptcy isn’t certain and hence it is better to get help of a local attorney to find out what the court does.
Nevertheless, there are some clear limitations on how the strategy of lien elimination can be used in Chapter 7.
First, you have to qualify for filing bankruptcy under Chapter 7. If you’re someone who makes a 6-figure salary per annum and own a stack of assets, Chapter 7 isn’t for you!
Second, you might not require being current on the payments of the first mortgage loan, but shortly after you file bankruptcy, you have to get current on this loan, irrespective of whether you’re behind for 2 months or even 2 years. If you’ve ceased making payments on your first mortgage just a few months ago, getting current might not be too difficult for you as you just need to heal the arrears. However, if you’ve stopped making payments months or years ago, getting out of that situation is easier said than done. No one who qualifies for Chapter 7 will have money lying around to clear arrears but you can try convincing a family member or a friend to pay off the arrearages and help you get current on the loan.
Third, the present value of the home should be less than the amount owed on your first mortgage. As long as this is the case, the entire second mortgage gets eliminated through Chapter 7 bankruptcy.
Hence, are you adamant about retaining your home? Do you have a second mortgage? If answered yes, check if you qualify for a Chapter 7 bankruptcy case.
Removing a second mortgage through Chapter 13 bankruptcy
Well, the process begins by filing a petition for Chapter 13 bankruptcy. The debtors along with their attorneys file a plan with the court to repay creditors using future earnings. The repayment plan of Chapter 13 bankruptcy may stretch from 3 years to 5 years, depending on factors like your monthly income and affordability. Prior to filing the case, the debtors and their attorneys should obtain a fresh appraisal of their home. After filing, the attorney will get in touch with the court to receive a hearing date to request an order to remove the lien from the property.
If the court approves the motion, the court will immediately issue an order where it directs the holder of the second mortgage to take the required steps to evacuate the lien from the home. The court has the authority to order the removal of a purchase money loan, a HELOC or any other type of mortgage or lien which is fully unsecured.
The stripping of second liens is just another lump of coal for the already-struggling financial sector of the country. The US lenders are sitting on nearly $1 trillion in home equity and second mortgage loans. Experts hope that the “second lien strip” might offer a new path to some over-leveraged homeowners. However, filing bankruptcy isn’t a painless strategy and it also has a bad impact on the consumer’s credit score.