Making Sense of Bankruptcy: Qualifying for a Second (or Third) Mortgage “Strip”
May 1, 2015
You can strip a junior mortgage from the title to your home if the home is not worth enough to have any of its equity covering that mortgage.
In our last blog post we explained the huge benefits of the Chapter 13 mortgage strip through the following sentence:
If you qualify for removing (stripping) your second or third mortgage from your home’s title, you would not have to pay that mortgage’s monthly payments, and you’d get much closer to building equity in your home but only at the successful completion of your case.
To get these benefits your home first has to qualify for stripping its mortgage. Today we explain how you qualify by focusing on the highlighted terms within the following sentence:
To strip a junior mortgage from your home’s title, the value of the home must be less than the combined amount owed on the the senior mortgage(s) plus any other liens that are ahead of that junior mortgage.
Lien Stripping of a “Junior” Mortgage under Chapter 13
By filing a Chapter 13 “adjustment of debts” case, under the right conditions you can not only discharge (legally write off) the entire debt you owe on a second or other junior mortgage but then also wipe the lien that secures that debt off your home’s title. All this, while keeping the home along with its much improved equity position—because you’ll owe that much less on the home than before the lien strip
But to be clear, this mortgage lien stripping applies only to second mortgages, and to third and other mortgages that are lower on the home’s title. You cannot strip the lien of your first mortgage. Indeed you cannot “modify” the terms of your first mortgage at all (except to have more time—up to 5 years–to catch up on any past-due mortgage payments).
The Value of the Home
Mortgage lien stripping has been a much-used tool particularly in the last half-decade or so after the Great Recession lowered the values of so many homeowners’ homes so significantly. The situation was aggravated by the fact during the years before that, home equity second and third mortgages were often handed out under very loose standards, without much equity to cover these junior mortgages from the start. And when the property values sharply declined, that often left no equity at all covering these second and third mortgages. Although property values in some parts of the country have climbed back up significantly, your own home’s value may still allow for a mortgage lien strip.
The value of your home is crucial because under Chapter 13 in particular the law puts a lot of weight on whether the collateral supposedly securing a debt is actually worth enough to be really securing it with value. So the law recognizes when a second or third mortgage has NO EQUITY securing it because that equity is all absorbed by liens that are senior to—come ahead of—that mortgage. Accordingly, Chapter 13 provides a nifty mechanism for establishing that a second or third mortgage which has no equity is actually an unsecured debt—the lien is stripped off the title, making that mortgage legally unsecured, since it had no value securing it.
The Balance Owed on the First Mortgage/Prior Mortgages
In general, you can strip the second mortgage if the balance owed on the first mortgage exceeds the value of the property.
So, for example, if your home is currently worth $200,000, you owe $205,000 on your first mortgage and $25,000 on your second mortgage, you can strip the second mortgage’s lien of your home’s title because all of your home’s equity is absorbed by the first mortgage, leaving no equity for the second mortgage.
But this also works if you have a third mortgage (a second home equity loan, for example). Then you compare the value of your home to the combined balances of the two prior mortgages. If all of the home’s equity is absorbed by the combination of the first and second mortgage balances, you can strip the third mortgage lien.
For example, if you owe $180,000 on your first mortgage on a $200,000 home, and owe $25,000 on a second mortgage and $15,000 on a third mortgage, because the combined balances of the first and second mortgages ($180,000 + $25,000 = $205,000) exceed the $200,000 value of the home, leaving no equity at all for the third mortgage, that third mortgage lien can be stripped off the home’s title.
Account for All Other Liens
Sometimes there are other liens on your home’s title that come ahead of the second (or third) mortgage that you are trying to strip. These prior liens may make stripping the second/third mortgage easier.
The most common prior lien is the one securing your property taxes. If you are behind on your property taxes, that may be a blessing in disguise when it comes to mortgage lien stripping because property tax liens generally come ahead of all other liens, no matter when they arose. Since a property tax lien absorbs some of the home’s equity, that makes more likely that there would be no equity left over for the second or third mortgage and thus able to be stripped.
Similar principles may apply to liens for homeowner association dues or assessments owed, as well as recorded state and federal income tax liens and child/spousal support liens, depending on their timing and your state laws on the ordering of liens. Even utility and municipal liens, construction liens, and other odd kinds of encumbrances on your home’s title can absorb equity ahead of the second or third mortgage you are trying to strip, again making more likely that there would be no equity covering that mortgage.
Stripping a mortgage lien allows you to stop paying that mortgage, and brings a home seriously under water much closer to having equity. Talk to a competent bankruptcy attorney about whether your second or third mortgage could be stripped from your home’s title to gain these immediate and long-term benefits.