A Fresh Start by “Stripping” Your Second Mortgage
Jan. 25, 2016
Stripping your second mortgage could give your home the very best fresh start by saving you a tremendous amount of money.
If You Can’t Afford the Monthly Payments on Your Home
Last week we compared three ways to save a home in which you’re behind on your mortgage payments: mortgage modification, a forbearance agreement, and Chapter 13.
Mortgage modification is the only one of these three which lowers the monthly payment on your first mortgage. A forbearance agreement just gives you a number of months to catch up on missed mortgage payments, during the same time that you are also required to make the usual monthly mortgage payments. Chapter 13 is similar except giving you much longer to catch up, up to 5 years. Stretching out the catch-up time greatly reduces the amount you have to pay per month compared to a forbearance agreement.
The problem is that mortgage modification is difficult to qualify for. Whether using a governmental program or one provided directly by your mortgage lender, there is a quite narrow window that your income must fit into in order to qualify. So what do you do if you don’t qualify for mortgage modification but still can’t afford what you have to pay each month towards your home?
Chapter 13 “Strip” Can Make a Dramatic Difference
One possibility If you have a second or third mortgage is to “strip” that mortgage off your home’s title through a Chapter 13 “adjustment of debts.” If you qualify you could immediately stop paying that mortgage’s monthly payments. So even though you’d have to pay your full first mortgage payment, not having to pay your second (or third) mortgage payment may make it affordable to keep your home.
Mortgage “Strip” May Make Chapter 13 by Far the Best Option
Such a mortgage “strip” could even be much better than a mortgage modification, both short-term and long-term.
A mortgage “strip” could be better short-term by making it cost less to keep your home. Not having to pay the second mortgage monthly payment could reduce what you have to pay more than a first mortgage modification would save you each month.
Consider this example. If the monthly payment on a first mortgage would be $1,250 and on a second mortgage $375, or a total of $1,625, “stripping” that second mortgage would result in the homeowner paying only the first mortgage payment each month, or $1,250. Even if a first mortgage modification would have brought the payment down significantly, say to $1,050 per month, that plus the regular second mortgage payment of $375 would still leave the homeowner paying $1,425 per month. That’s more than the $1,250 per month with the second mortgage “strip.”
A second mortgage “strip” can also be better long-term because it very likely reduces the total you’d pay on your home compared to a mortgage modification. That’s because mortgage modification seldom includes a reduction in the principal to be paid on the debt. Instead the reduced monthly payment often comes with a steep long-term price tag—much more interest has to be paid because the payments on the same principle is usually stretched out over a longer period of time.
In contrast the second mortgage “strip” effectively reduces the principal owed on that mortgage to nothing or very little, lowering the amount owed on the home by that amount. That’s especially saves money in the long-run because second mortgages tend to have higher interest rates than first mortgages.
Consider the example of a home with a first mortgage of $200,000 at a 5% interest rate and a second of $35,000 at a 9% interest rate. Depending on how long the homeowner stays in the home paying the mortgages, the amount of interest paid often greatly exceeds the amount of principal paid. By not having to ever pay all or much of that $35,000 higher-rate second mortgage, the homeowner can hugely reduce the amount of combined interest and principle paid in subsequent years.
Qualifying for a Mortgage “Strip”
To strip a second mortgage from your home’s title, the value of the home must be less than the combined amount owed on the first mortgage plus any other liens—such as for property taxes—that are legally ahead of that second mortgage. In other words, there can’t be any equity in the home that secures the second mortgage. All the equity must be eaten up by the amount of the second mortgage, unpaid property taxes, homeowner’s association arrearage and such.
To strip a third mortgage from your home’s title, the value of the home must be less than the combined amount owed on the first and second mortgages plus any other liens—such as for property taxes—that are ahead of that third mortgage.
Chapter 13 Only, and Only Successful Ones
There is no ability to “strip” a mortgage in a Chapter 7 “straight bankruptcy.” You have to file a Chapter 13 “adjustment of debts,” which usually takes 3 to 5 years to finish.
And you have to successfully get to the end of your Chapter 13 case by making your court-approved plan payments and meeting other requirements. After you’ve done so, your second (or third) mortgage lien is stripped off your title. Whatever portion of that mortgage that has not been paid through the Chapter 13 payment plan is then discharged—legally written off. Your home no longer has that mortgage on its title or has any of that debt against its equity.