In most bankruptcy cases, your home mortgage is not affected, and if you want to keep your home, you have to continue the payments. However, there is an important exception to this rule which applies in chapter 13 cases.
If your home is worth less than what you owe on your mortgages, to the point where the second or third mortgage is not secured by your home’s market value, you can remove the mortgage and never have to pay it. Sound impossible? Well, it’s not impossible; in fact, it’s done all the time. Here’s how it works.
Let’s say your home is worth $250,000 and the first mortgage has a balance of $255,000. Let’s also say you have a second mortgage with a balance of $40,000. Because the home is worth only $250,000, the second mortgage is not secured by any value.
The law says a chapter 13 case can remove a wholly unsecured mortgage. Note that in this example, removing the mortgage could not be done if the home were worth $260,000, because then there would be some value securing the second mortgage.
You need to file a bankruptcy court lawsuit against the second mortgage holder to obtain a court order removing the second mortgage. This could invite expensive litigation over over your home’s true market value; hence the reluctance to pursue this option with more frequency.
However, there’s a simple way to avoid this problem: include a provision in your chapter 13 plan which specifies your home’s market value, the balance owed on the first mortgage, the balance owed on the second mortgage, and stating that these figures are binding on the creditors involved, and naming them. Your chapter 13 plan needs to explicitly state that when the court confirms your plan, these figures are binding on the second mortgage holder, as a federal court order, and that the second mortgage holder cannot re-open later the question of your home’s market value. Most court districts recognize such a provision as being binding on the creditor if it fails to object.
Later, when you file your bankruptcy court lawsuit to remove the second mortgage, the second mortgage holder is bound by the market value figure you specified in your chapter 13 plan. This means the second mortgage holder cannot effectively defend against your request, because if the market value is known, and if the second mortgage is wholly unsecured, then the court should grant your request no matter what the second mortgage holder has to say about it.
The best part of this strategy is that it enables you to avoid spending time and money on a lawsuit in bankruptcy court over your home’s value, because the second mortgage holder has been hamstrung by your chapter 13 plan’s fixing of your home’s market value.