Most people find that their biggest debt relates to their home mortgage. More recently, many of my clients have discovered that the value of their homes has gone down – sometimes a home may be worth tens of thousands of dollars less than what is owed.
In 2009, the United States Congress considered a bill that would have allowed bankruptcy judges to modify mortgages. Supporters of this bill argued that such a provision would help stabilize the mortgage market and encourage “underwater” homeowners to stay in their homes. This mortgage modification bill did not pass in the 2009 Congress.
However, the Bankruptcy Code does provide some relief for homeowners who have at least two mortgages (a first and a second mortgage). Bankruptcy Code Section 506 allows for something called lien stripping in Chapter 13. When a lien is stripped it is treated as an unsecured debt in a Chapter 13 plan. If your plan pays unsecured creditors 15 cents on the dollar, the send mortgage holder gets only 15 cents on the dollar.
If you have a second mortgage or home equity loan (HELOC), you may be able to cancel this type of mortgage obligation in a Chapter 13 bankruptcy.
Known as lien stripping, 2nd mortgage cancellation works only if your home is worth less than the balance due on your first mortgage. If your home is now worth less than the balance due on your first mortgage, there is no equity for your second mortgage holder’s lien – and bankruptcy law allows you to cancel this lien as part of your Chapter 13.
Let’s look at an example to better understand how lien stripping works:
Example 1: Tom purchased his home in 2005 for $250,000. He currently owes $175,000 to Countrywide Mortgage and $50,000 to Ocwen Mortgage. Home values have dropped in the neighborhood and Tom’s house is now worth $160,000. Since his home value of $160,000 is less than the $175,000 balance due Countrywide, Tom can file Chapter 13 and stip the Ocwen 2nd mortgage.
- In this example, there is no equity or security to cover Ocwen’s interest. The Bankruptcy Code says that if no equity attaches to the Ocwen loan, this loan can be stripped away and the balance due Ocwen will be treated like any other unsecured debt.
In the Northern District of Georgia, lien stripping does not happen automatically – we need to file a motion to strip the lien and serve a copy of that motion on the Chapter 13 trustee and all creditors. The local rules for the Northern District of Georgia contain very specific requirements of service – for example, it is not sufficient to send a copy of the lien strip motion to the 2nd mortgage holder’s payment address. Instead, we must serve the motion upon a corporate officer and on the lender’s registered agent for service in Georgia.
In many cases, the second mortgage lender will not respond to the motion to strip lien. If they do respond, they may try to argue that our valuation of the property is too low. In such a case, we might have to submit appraisals or even bring an appraiser with us to court to testify about the valuation.
Given the downturn in the real estate markets, however, more and more lien strip motions are not contested and when the 2nd mortgage lender does not oppose the motion it will be granted by the judge. In the video below, I discuss more about lien stripping.
What Does it Mean When Lien Strip Motion is Granted?
If we are successful in stripping away your 2nd mortgage lien, we still have to account for the lien balance in your Chapter 13. However, the lien balance will be treated like an unsecured debt and paid at the same rate as other unsecured debts such as credit cards and medical bills.
If your Chapter 13 plan proposes a 75% payback to unsecured creditors then lien stripping will not help you as much as you might think. If we decide that your case is appropriate for a lien strip then we need to factor the stripped lien balance – once unsecured – into our Chapter 13 plan calculations.
Lien stripping can be a powerful tool in your Chapter 13 but we cannot approach the process without thought and preparation. If you think that your 2nd mortgage or HELOC might be a lien that we can strip, please call our office at 770-393-4985, or email us to discuss.