Lien Stripping – Using Bankruptcy to Wipe out Second Mortgages

17 Oct Lien Stripping – Using Bankruptcy to Wipe out Second Mortgages

If your house is worth less than the first mortgage, you can wipe out second mortgage liens in a chapter 13 bankruptcy case. This is through a procedure called “lien stripping”. Basically, you do have to pay what you owe under a chapter 13 plan. However, you first get the court to declare that the debt of the second mortgage lender is unsecured.

How does this work and why does this work now?

Think of it this way. So many houses were purchased in the early 2000s on so called “80-20” loans. The 80% loan was the normal first mortgage that lenders like. The 20% loan was money that home-owners borrowed because they did not have cash to pay the 20% down payment that lenders like. So the home-owners ended up buying their houses for no money down. The 20% second mortgages were risky. They carried higher interest rates. Often they were treated as Home Equity Lines of Credit (HELOC).

Now, home prices have dropped more than 20%. In fact, they have dropped more than 25% and even more in some neighborhoods.

This means that the 20% second mortgage is now 100% underwater. Bad news for the lender. Good news for the borrower.

In chapter 13 wage-earner plan bankruptcy case, the second mortgage is now a completely unsecured claim. In chapter 13, if you pay that claim through a chapter 13 plan, not only is the claim wiped out but the mortgage lien is also wiped out. The chapter 13 debtor – homeowner pays his or her disposable income for 3-5 years depending on the case. This may work out that the second mortgage holder and other unsecured creditors get less than 100% of their claims. It doesn’t matter. If the home-owner debtor completes his or her plan, the debt is wiped out and so is the mortgage.

Lakelaw represents homeowners in bankruptcy cases in Illinois and Wisconsin and handles lien stripping cases.

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Jay S. Fleischman is a bankruptcy lawyer with offices in Los Angeles and New York. He can often be found on Google+ and Twitter, where he shares information about consumer protection issues and personal finance.
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