Bankruptcy and your Second Mortgage

11 Aug Bankruptcy and your Second Mortgage

People in chapter 7 bankruptcy frequently face foreclosure. They owe more on their first mortgage than their house is worth. Maybe they even have a second mortgage. That second mortgage could be a line of credit or a HELOC or just a plain vanilla mortgage loan. But, the house has gone down so far in value that the second mortgage has no equity in the house to support it. The second mortgage is fully unsecured.

You may have a choice. You could file a chapter 7 bankruptcy if you are eligible under the means test. If you are eligible to file a chapter 7 case, you could eliminate your personal liability for both mortgages. You could decide to just pay on the first mortgage. You take a calculated risk that the second mortgage holder would foreclose. But why would they? They would end up with a house subject to a first mortgage more than it’s worth.

Another option is “lien stripping” in chapter 13. Here, you have to pay your disposable income to a chapter 13 trustee under a plan for 3-5 years. But then, the totally unsecured mortgage is wiped away and no longer a lien on your house. Many courts say you have to get a chapter 13 discharge in order to use this lien stripping procedure.

There’s a split among the courts whether or not you need a discharge in chapter 13 to strip off a fully unsecured lien. It may take a few years before the courts work out a definitive answer. Some lawyers call a chapter 7 case followed by a chapter 13 case a “chapter 20”. There is no such case under the law but it does show that people know how to add 7 + 13, doesn’t it?

It does seem certain that you won’t be able to “strip” your fully unsecured mortgage in a chapter 7 case.

The benefit of staying in your house after chapter 7 is that it might be cheaper than rent. The second mortgage is no longer an economic issue, so just ignore it. You might be able to strip it right away in chapter 13 and if economic conditions don’t improve, you might be able to strip it 4 years from the date you filed your chapter 7 case – when you are eligible for a discharge under chapter 13.

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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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