Chapter 7 and Chapter 13–Stripping a Second (or Third) Mortgage
Oct. 21, 2015
Stripping a mortgage from the title to your home could save you a tremendous amount of money.
Two blog posts ago our topic was getting rid of judgment liens, which can be done under either Chapter 7 “straight bankruptcy” or 13 “adjustment of debts.” So if you have a judgment lien (or two) on your home’s title, that will not push you towards one Chapter or the other.
But stripping a second mortgage can only be done through Chapter 13. Because stripping a mortgage from your home’s title can save you so much money, it is often the major reason to file under Chapter 13 instead of Chapter 7.
The Benefit of Stripping Your Second and/or Third Mortgage
If you qualify to remove, or strip, a mortgage from your home’s title, you would not have to pay that mortgage’s monthly payments, would likely pay only a fraction of that mortgage, and get much closer to building equity in your home. Under the right conditions, you can get rid of the debt you owe on a second or other junior mortgage, and get rid of the lien on your home’s title securing that debt.
You can do this by filing a Chapter 13 case if the value of the home is less than the amount owed on the your first mortgage plus any other liens that are ahead of the mortgage being stripped (such as for property taxes or a homeowners’ association).
Usually in bankruptcy a lender’s rights to its collateral are respected and protected. For example, if you want to keep your vehicle you have to pay the lienholder. So it’s both unusual and very beneficial to you to be able to get rid of a junior mortgage debt as well as its mortgage lien on your home.
Stop Monthly Payments
If you file a Chapter 13 to strip your second or third mortgage you immediately no longer have to make the monthly payments on that mortgage. And if you were behind on those mortgage payments, you do not have to catch up on those payments.
Improve Your Equity Position in Your Home
If you can get strip a second or third mortgage doing so can bring you much closer to creating equity in your home.
An example will show you how this works. If you had a home worth $200,000, with a first mortgage of $210,000 and a second mortgage of $30,000, you could likely strip that second mortgage through Chapter 13. Instead of having a negative equity of $40,000 ($10,000 from the first mortgage plus $30,000 from the second), after the lien strip the negative equity would be only $10,000, bringing the home much closer to building equity through future increases in the value of the home.
What Happens to the Debt Owed on the Stripped Mortgage?
Chapter 13 allows you to treat the debt being stripped of its mortgage like a “general unsecured” debt. Those are debts with no lien on anything you own, which are paid only as much as your budget enables you to pay during the life of your 3-to-5-year Chapter 13 case, which is often not very much.
That’s because you are allowed, indeed required, to pay your secured debts and “priority” debts ahead of the “general unsecured” ones. Secured debts include vehicle loans and first mortgage arrearage. “Priority” debts include, for example, income taxes that are not old enough to be discharged (written off), any child and spousal support that you’re behind on, and other legally important debts.
As a result the debt on your mortgage that’s being stripped is usually paid only a few pennies on the dollar, and sometimes nothing at all.
Furthermore, because in most cases you only have to pay a certain amount to the entire pool of your “general unsecured” debts, adding your mortgage debt to that pool usually doesn’t increase what you have to pay in “general unsecured” debts.
For example, let’s say your budget over the course of your 3-year Chapter 13 payment plan requires you to pay—beyond what you are paying to secured and “priority” debts—$5,000 to the pool of your “general unsecured” debts. Imagine that you owe $20,000 in credit card and medical debts, and $30,000 on a second mortgage being stripped. Without that second mortgage debt, the $20,000 in credit card and medical debts would be paid 25%—$5,000 out of the $20,000 owed. When you add the $30,000 second mortgage debt to this pool of “general unsecured” debts the pool increases to $50,000. Paying the same $5,000 during the 3-year plan towards this $50,000 in debt results in the debts now being paid only 10%—$5,000 of the $50,000 owed. The amount you would pay—$5,000—would not change; it would just be spread out over more debts, without costing you any more.
At the Successful Completion of Your Case
Once you get to the end of your Chapter 13 case by having paid whatever your court-approved payment plan required of you, 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 any of that debt against its equity.