Stripping Wholly Unsecured Junior Mortgages

First mortgages on primary residences are specially protected from modification in bankruptcy. So, for example, when the value of a home decreases below the value of a first mortgage, a debtor has no ability to modify the debt in bankruptcy while keeping the home. This is one of the things that Congress debated during the recent TARP/bailout legislation, but no changes were made to existing law.

The same anti-modification rules do not apply to mortgages on properties that are not used as one’s primary residence. Importantly, they also do not apply to second, third, and even more junior mortgages if they are “wholly unsecured”–even if they are secured by a primary residence. A debt is wholly unsecured if no part of value of the collateral secures it. This is easier explained with an example. If a home is worth $200,000 and the first mortgage payoff is $190,000 and the second mortgage payoff is $50,000, the second mortgage is not wholly unsecured because $10,000 of the value of the collateral secures it. However, if the home is worth $200,000 and the first mortgage payoff is $205,000 and the second mortgage payoff is $50,000, then the second mortgage is wholly unsecured because none of the value of the collateral secures it.

Wholly unsecured junior mortgages are more and more common now as real estate values sink. If you have a wholly unsecured junior mortgage, you can discharge it in a Chapter 13 bankruptcy–while keeping your home. Note: this option is not available in Chapter 7 bankruptcy. This can result in a huge financial benefit for a homeowner, especially one struggling to keep up with multiple mortgages. If this situation applies to you, I advise contacting a bankruptcy lawyer as soon as possible.