What is Lien Stripping and who can Benefit?
People who are considering Chapter 13 bankruptcy may be able to benefit from a practice known as lien stripping. This in essence is the process of forgiving or stripping away debt that is normally ineligible to be written off. In previous years, this practice was virtually unheard of, but factors surrounding the present housing market have caused this to be a very common occurrence.
Chapter 13 bankruptcy involves setting up a schedule for the repayment of the debtor’s debt based on his income. The first debts that are normally paid are secured ones that have a piece of property attached to them. Home and car loans generally fall into this category, as the property can be repossessed in the event of non-payment. Non-secured debts are ones that do not have property attached and are among the last to be paid under Chapter 13.
People who have taken out a mortgage only to find the value of their home has fallen may be eligible for lien stripping. This happens whenever more money is owed on a primary mortgage than the real estate is worth because property values have decreased. The excess amount owed on the primary mortgage means that subsequent home loans are now unsecured and eligible to be discharged by a bankruptcy judge.
An example of an unsecured second mortgage would be this: A couple purchased a home five years ago for $250,000. Two years later they took out a second mortgage for $50,000. They now owe $220,000 on their first mortgage and $45,000 on their second mortgage. The value of the home is now only $200,000. The debtors are now under water and may apply lien stripping rules to the second mortgage.
Even if the value of certain real estate is less than the amount owed on the first mortgage, this loan is still fully secured. This is because the law requires that first mortgages be wholly secured ones regardless of the circumstances. As a result, debtors are unable to write off any of their remaining first mortgage amounts even if the amount greatly exceeds the value. In the case above, the family may not be relieved of the additional $20,000 debt on their first mortgage loan.
A second mortgage can also be fully secured even if the loan causes the amount borrowed to exceed the property value. This is because discharging mortgage loans requires an “all or nothing” application. This means that if there is even a small amount of equity left after satisfying the first mortgage, the second one is also fully secured and cannot be stripped away.
An example of this would be when a homeowner purchases a home valued at $275,000 for $200,000 and then takes out an additional mortgage for $60,000. Shortly thereafter, the value of the home plummets to $210,000. This is still greater than the amount on the original mortgage, which means some of the equity carries over to the second home loan. In this instance, neither loan is eligible for lien stripping.
Can you strip a lien when only one spouse if filing for bankruptcy or one spouse dismissed the chapter 13 case after filing?
I would say yes, because the lien stripping is an in rem action. I used the term on purpose to confuse readers. This is Latin and means “against property”. If the lien is stripped of as to the property, the non-filing spouse should be able to benefit from it. I can see however, a title company making problems about this question later on when you try to sell your house. I would advise to file jointly if a lien strip is planned.
If you are underwater with your mortgage, do you still have to strip the second mortgage, can’t you just file a chapter 7?
First, what means being underwater with your mortgage? It means that your house is worth less than the mortgage. The question is, can the lien holder for the second mortgage do anything if they don’t get paid anymore? The answer is yes, they can, they still can start a foreclosure proceeding. The first mortgage would get paid first and the second mortgage would not get anything, but they still could start a foreclosure. The same is true by the way with Judgment liens. As soon as a judgment lien is on your house, your creditor can commence foreclosure proceedings, no matter if he will receive any proceeds from the sale of your home.
You have three options: File a chapter 7, and then strip down the lien in a subsequent chapter 13 without discharge. File a chapter 13, strip the lien and receive a discharge (Fisette, decided by 8th Circuit). Or file a chapter 7 and settle with your second mortgage company the second lien.
Lien stripping is done by adversary proceeding and in most cases incurs additional attorney fees which should be paid through the chapter 13 plan. The attorney would file an application for additional fees and a “Notice and Summary of Application for Compensation”.
The most important question when stripping down a lien: How do you value your property?
The debtor’s estimate is not good enough. You should have an appraiser and if there is a dispute with the mortgage company about the current value, your appraiser should be ready to testify in court. It that situation it is also possible to settle the dispute with the mortgage company and agree on a value. If you are in the St. Louis area, our office knows appraiser with many years of experience who can testify in court. In disputes between mortgage company and debtor about valuation, it also depends on which Judge will make the decision. Even though your bankruptcy attorney will never know the outcome of a adversary proceeding, he might be able to assess the chances considering all factors, including who is the appraiser who will testify in court, and who will be the judge to make a decision. Some Judges consider the lien stripping a loop whole that was not intended by Congress and might side with the creditors when the evidence is not supporting debtor’s valuation. However, the new bankruptcy law did not change or correct the language in the Bankruptcy Code, it is good law.