The Advantages of Stripping Away Your Second Mortgage in Bankruptcy
In Bankruptcy cases, specifically Chapter 11 and Chapter 13, lienstripping is an effective tool in reducing the payments made to creditors. In Chapter 13, the debtors reorganize their debts into a repayment plan whereas Chapter 11 is for businesses and individuals whose debts exceed the limits in Chapter 13.
One of the biggest advantages of filing and completing a Chapter 13 bankruptcy is that it provides you with the option of filing a separate motion to remove all junior liens against your real property. This process is called a ?lien strip.? A lien strip is a legal remedy that provides that, if the value of your home is below the amount owed on your first mortgage, you may be able to strip the security from your second and/or third mortgages. This means that, upon discharge of your Chapter 13 bankruptcy, you will no longer have the junior liens on your home, and the property will vest in you free and clear of the former junior liens.
Lien stripping is referred to as the debtors? ability to reduce an undersecured creditor?s claim by valuation of the underlying collateral. This is also known as bifurcation where the undersecured creditor?s claim is divided into secured portion and unsecured portion. The unsecured portion of the lien is stripped away from the collateral and becomes an unsecured claim. For example, if a debtor purchased a commercial building with a mortgage of $500,000 and the current value of the building is $300,000. The creditor?s lien is undersecured and can be bifurcated into $300,000 secured claim and a $200,000 unsecured claim. The debtor is only required to pay back $300,000 over the life of the loan and the remaining $200,000 can by discharged at the end of a successful plan. Under nonbankruptcy laws, the debtor is required to pay the entire amount since lien stripping is unique to bankruptcy cases. Lienstripping is not available in Chapter 7 cases which are used in discharging unsecured debts because liens ride through Chapter 7 cases untouched.
However, there are limitations as to what the debtor can do in valuing claims on the primary residence and vehicles financed within 910 days. Congress in its wisdom has prohibited individuals from modifying loans on their primary residence. If the debtors have one mortgage on their home, they cannot reduce the loan to the value of the house. However, the debtor is allowed to strip away a second mortgage that is not secured by the value of the house. For example, if the debtor has a first mortgage of $300,000 and a second mortgage of $100,000 and the house has a value of $250,000, then the debtor is allowed to strip away the second mortgage. In Chapter 13 cases, Congress applied another limitation to stripping liens on vehicles financed within 910 days of filing bankruptcy. A vehicle that has been financed longer than 910 days can have its lien reduced to the value of the collateral which allows the debtor to make reduced payments based on the current value of the vehicle and not the outstanding balance of the loan. The interest rate can also be reduced to the current market rate and the debtor is not required to pay the contract rate.
Tax liens can be stripped off in reorganization proceedings such as Chapters 11 and 13 cases to the extent that the lien does not attach to equity in property. Tax liens can’t be avoided in Chapter 7 on the grounds that they impair exemptions; if the tax is dischargeable in the Chapter 7, the bankruptcy court can determine the amount of the lien that is secured at the time of the filing. Payment of that sum entitles the debtor to the release of the lien.
Joseph E Seagle, bankruptcy attorneys
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