Lien Stripping During Bankruptcy

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The Bankruptcy Code has a provision for lien stripping. Liens can be stripped off of the debtor's assets in when there is not enough equity in the asset, after deducting senior liens from the property's current market value, to secure the unsecured in whole or in part, where the lien exceeds the value of the debtor's property.

Lien stripping explained

Lien stripping means reducing a secured claim to the value of the underlying collateral. The lien is bifurcated into secured and unsecured. The secured lien is allowed in the amount up to the fair market value of the property at the time of the stripping. The balance of the lien, which exceeds the fair market value of the property, is now deemed unsecured.

Lien Stripping in Chapter 13 Bankruptcy

11 USC 1322 states that someone filing a Chapter 13 bankruptcy plan may modify the rights of holders of secured claims, other than a claim secured only by a security interest in real property that is the debtor's principal residence, or of holders of unsecured claims, or leave unaffected the rights of holders of any class of claims. Although not expressly stated, this section has been interpreted by many judges to mean that a mortgage cannot be modified if it is secured by the debtor's principal residence. But it can be used for second mortgages and where the mortgage is secured by investment property. The bankruptcy court splits the outstanding mortgage balance into two parts. The amount of debt equal to the current appraised value of the security is treated as a secured claim, which the debtor must continue to pay. The amount of debt in excess of the current property's value becomes an unsecured claim, which is usually not repaid in full.

Lien Stripping in Chapter 7 Bankruptcy

Although a few bankruptcy courts have allowed debtors under Chapter 7 to strip liens, in general, this lien stripping tool can only be used by debtors under Chapter 13.

Getting Legal Help

Bankruptcy is a complex process. Unless it is properly done, the Bankruptcy Court can disallow your lien stripping. A small error or mistake can prove costly. Not only will your lien stripping be disallowed, your bankruptcy petition can also be rejected. An experienced bankruptcy attorney can study your case and advise you on lien stripping.