How to Avoid 2nd Mortgage Debt in Chapter 13 Bankruptcy

Chapter 13 2nd Mortgage Lien Stripping

2nd mortgages and HELOCS (Home Equity Lines of Credit) can be stripped and avoided in Chapter 13 cases to the extent that the value of the mortgaged property has decreased to less than the amount owed.

Secured Debt Classification

2nd Mortgages are secured debts. However, they can be re-classified as unsecured debts where the value of the mortgaged property has become less than what is owed. Because the 2nd mortgage lender's lien is in an inferior position to the 1st mortgage lender's, the 2nd mortgage lender's foreclosure rights vanish in a Chapter 13 bankruptcy because their lien is reclassified as an unsecured debt,  therefore dischargable in Chapter 13 Bankruptcy. To the extent that the fair market value of the property has fallen below the total amount owed, the 2nd lien holder is grouped with unsecured creditors. Because Unsecured debts are dischargeable in bankruptcy,  2nd mortgage debts can therefore be avoided in Bankruptcy.

Example of How Mortgage Stripping Works

A home owner has 2 mortgages on her house - a 1st Mortgage of $50,000 and a 2nd mortgage (or HELOC) of $10,000 [total mortgage debt of $60,000]  The local real estate market is weak. A local appraiser reports the fair market value of the property to be only $50,000. Here, the 1st Mortgage of $50,000 is still secured by the appraised value. However, the 2nd mortgage has become wholly unsecured, because there would be nothing left to pay the 2nd mortgage lien after the superior 1st mortgage lien can be satisfied.

To accomplish the avoidance of the 2nd mortgage, the debtor's attorney files a motion to avoid the 2nd lien in the debtor's Chapter 13 Bankruptcy case, [a Chapter 13 lien stripping motion]. Included in the pleadings are facts and law establishing the decrease in value and supporting legal authority for re-classification of the 2nd Mortgage lien as an unsecured lien.  The 2nd Mortgage can therefore be avoided or "stripped".

Effects

A) The 2nd mortgage lender loses its foreclosure rights.

B) The 2nd mortgage debt is reclassified as unsecured debt, and is grouped with other unsecured creditors {low man on the totem pole]. The debtor then repays only a small % of the 2nd mortgage debt owed (usually a small % of the arrears only) in planned payments spaced over a 3-5 years. Payment amounts are based on the debtor's available "disposable" income, so the debtor can get back on her feet and keep her home. The risk is more fairly apportioned this way - the lender's risk is brought into market reality - relieving the debtor of of having to bear 100% of the financial risk associated with market depreciation.

C) A proposed order is attached to the motion for the court's approval which directs that If the Chapter 13 debtor completes her scheduled payments, the 2nd mortgage lender must reconvey the property to the debtor by issuing a release of the the mortgage and the lien and, recording the release of lien with the county recorder.