How is a HELOC Treated in Bankruptcy?

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A Home Equity Line of Credit (HELOC) is treated like a second class citizen in bankruptcy.  In a Chapter 13, a HELOC may be stripped of its lien on the property when the property is worth less than the first mortgage balance.

How a HELOC Can Be "Stripped"

Your bankruptcy attorney would file a motion to determine secured status of the HELOC providing proof of the amount owed to the first mortgage and the value of the property. 

The value can be shown through an appraisal, a broker price opinion (BPO), or simply recent comparable valuations (comps). 

Lender Opposition

The HELOC lender can oppose the motion but often does not bother to respond when the values are clear.  In Florida, with the severe decline of the property market we are stripping plenty of second mortgages and HELOC loans. 

It is pretty much the only way to force a lender to accept a principal reduction at present and avoid yet another foreclosure. The court then enters an order stripping the lien.

The Remaining Unsecured Debt

However, the debt does not completely disappear.  The owner of the HELOC can file a proof of claim of the amount owed which is now an unsecured debt (the lien on the collateral home was eliminated). Unsecured debt in a bankruptcy receives payment only if the debtor has the means to pay. The HELOC lender may receive only pennies on the dollar if there is very little disposable income.

Lien is "Permanently" Stripped Upon Plan Completion

The debtor must complete the 3-5 year Chapter 13 Plan for the lien to be permanently stripped from the property.  If the case is dismissed for lack of plan payments or any other reason, the benefits obtained in the prior order stripping the HELOC are lost.

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