27 Mar Can A Second Mortgage Be Wiped Out in Bankruptcy?
It is no secret that lenders have been doing some pretty crazy things over the last few years to feed the real estate frenzy that took place nationwide from about 2000 until 2006. It is also no secret that the housing market bubble has burst, and home values have been steadily declining over the past 18 months. This may create an opportunity for homebuyers to get much needed relief in bankruptcy.
Traditionally, if a buyers had less that 20% of the down payment to pay at closing, the mortgage company required that the buyer pay primary mortgage insurance (“PMI”). PMI is extra insurance that lenders require from most homebuyers who obtain loans that are more than 80 percent of their new home’s value. To avoid paying PMI, lenders began to allow buyers to borrow a second loan equal to the 20% down payment which was secured by a second mortgage on the home.
The result has been many homes purchased with 100% or, in some cases, even 125% financing. With the down-turn in the housing market, many of these “no-equity” borrowers have become “negative-equity” borrowers, owing more money on their homes than they are worth. In an increasing number of cases, the value of the home is not even worth the balance owed on the first mortgage, especially if additional fees and costs have been racked up in the foreclosure process.
In a Chapter 13 bankruptcy, a debtor can completely wipe out any second mortgage that is wholly unsecured. For example, if a house is worth $125,000, but there is $125,001 or more owed on the first mortgage, subsequent mortgages can be completely eliminated. Within the bankruptcy case, the debtor files a lawsuit (known as an “adversary proceeding”) against the second mortgage company, even if the second mortgage is held by the same company as the first mortgage.
The debtor must provide evidence that the value of the home is less than the amount of the first mortgage. Sometimes, that can be accomplished through the county property appraiser’s records, or even by hiring an appraiser to value the house. Given depressed “comparables” (i.e. other sales in the same area), it is possible that the value is now low enough to convince a bankruptcy judge to wipe out all mortgages after the first mortgage.
For debtors struggling to save their homes, this strategy should be explored by the debtor and the debtor’s attorney.
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