In our last blog we talked about how reduced home values can be an advantage if you file a bankruptcy case. We showed how lower values can help you keep your home if you file a Chapter 7 case, and how it can reduce what you have to pay to your unsecured creditors in a Chapter 13 case. Today we talk about taking advantage of lower home values through judgment lien avoidance in either Chapter 7 or 13, and “stripping” second mortgages in Chapter 13.
Judgment Lien Avoidance
If you have been struggling financially for a while, a creditor may have sued you and then gotten a judgment against you. Most of the time, that judgment would be a lien against your home. In fact, probably one of the main reasons a creditor would go through the expense of suing you would be to get that judgment lien, as a way of pressuring you to pay the debt. That’s because in many situations a judgment lien gives the creditor the right to seize and sell your home to pay off the debt secured by that lien.
Bankruptcy—either Chapter 7 or 13—provides a way to get rid of judgment liens, but only if the amount of equity you have in your home (before accounting for the judgment lien) is LESS than the homestead exemption. Basically, you get to preserve equity up to the amount of your homestead exemption ($40,000 for a single person, $50,000 for a married couple), and to “avoid” any judgment lien which “impairs” (eats into) the applicable homestead exemption. If you have equity in your home (again, before accounting for the judgment lien) which is larger than the homestead exemption, then you would not be able to “avoid” the judgment lien, or not all of it, depending on the amount of the judgment and the amount of your equity.
So, if your home has fallen in value leaving equity that is no more than the homestead exemption amount, you will now be able to “avoid” the entire judgment lien, whereas you would not have been able to earlier. You would be able to write off the debt and have no judgment lien against your house after your bankruptcy is finished.
“Stripping” Second Mortgages in Chapter 13
If you file a Chapter 13 case and your second mortgage is completely under water (your first mortgage balance plus unpaid property taxes is larger than the value of the home), we can “strip off” the lien securing this mortgage against your house. This turns this secured debt into an unsecured one. Then during the three-to-five years that your Chapter 13 case takes to run its course, you pay relatively little on this now unsecured debt (or sometimes even pay nothing). Assuming you finish your case successfully, whatever is left unpaid on that debt at the end of your case is completely written off. And if you kept your house and maintained your other obligations on it, that second mortgage and its lien against the title will be gone forever as well.
When you took out that second mortgage, your home was very likely worth enough to cover that second mortgage. The reduction in your home’s value is what caused your second mortgage to be completely under water, thereby allowing this lien “stripping.”