Second and Third Mortgages Mean You Have No Equity? The Benefits of a Chapter 13 Filing!

Recently, I filed a chapter 13 bankruptcy for a couple who had a first mortgage of approximately $130,000 on their residence, along with a second mortgage of $34,000. While talking with the couple and reviewing their county property tax statement, I noticed that the county had valued the residence at $110,000.

I asked how on earth they had gotten mortgages so far in excess of the value of the property. It turns out that they had taken out an 80/20 loan some time back and had put no money down on the property. Over a year ago, they had refinanced both mortgages, had had the same mortgage company for approximately a week, and then the second mortgage was transferred to another servicer.

The refinance appraisal, done by the refinance mortgage company had valued their home at $160,000. Since the home was a mobile home, over 20 years old, this was difficult to believe. Their original mortgage and the refinance were both considered subprime mortgages. My colleague, Kurt O’Keefe, over at the Mortgage Law Network, recently discussed how subprime lenders frequently over-value property in order to loan higher amounts to borrowers.

The Bankruptcy Code allows a debtor to “strip” an unsecured lien from their residence. If the second mortgage has no equity to attach to, it is really and truly and unsecured lien. Our first step was to get a local realtor to perform a market analysis–how much was this property worth? The local realtor thought it would sell for $106,000. The market analysis didn’t cost any money–so far, so good.

The next step was to discuss with the client whether they were willing to have a professional appraisal done. Local appraisers charge $400. Spending $400 and being able to walk away in 36 months at the end of their Chapter 13 bankruptcy without a $34,000 second mortgage made sense to the couple.

The appraiser valued the house at $106,000 due to its age and need for repairs. At that point, an adversary proceeding (a lawsuit in bankruptcy court) to ask the judge to determine that the value provided by the appraiser was in fact the value and that the second mortgage should be treated as an unsecured debt. We served the lawsuit on the first mortgage company and the second mortgage company. Three weeks later, having reviewed the pleadings, the second mortgage company agreed that the debt was unsecured.

This benefit is only available in Chapter 13 filings. It can be a remarkable tool to assist debtors to get their fresh start. If you are contemplating filing bankruptcy and believe your house is not worth as much as you owe on the first mortgage, then speak with a qualified bankruptcy attorney to find out if this benefit is available to you.

There are con artists across the country who will try to convince you that this lien stripping can be done outside bankruptcy. See my colleague, Susanne Robicsek’s article from early 2007 about a group of con artists who scammed folks in North Carolina.