Mistakes to Avoid–Selling Your Home without First Stripping the Second Mortgage
Sept. 9, 2015
One way that bankruptcy—Chapter 13 in particular—could save you a tremendous amount of money is with a second (or third) mortgage strip.
If you have serious financial pressures inducing you to sell your home, is it partly because of your second (or third) mortgage? Would you it help if you did not have to make that payment anymore? Would you be able to keep your home, maybe even permanently, if you could stop paying that second or third mortgage (or both) and also get relief on your other debts?
If your home is worth no more than what you owe on your first mortgage, that is what the Chapter 13 “adjustment of debts” version of bankruptcy could accomplish for you. That and get you much closer to building equity in your home again.
Secured vs. Unsecured Debts
Debts are either secured by something you own or they are unsecured. Secured debt includes your vehicle loan, contract purchases of furniture and appliances, sometimes secured credit cards, as well as various kinds of debts secured by your home. Debts secured by your home can include not only first, second and third mortgages, but also any property taxes you owe (almost always the first debt against your home’s title, even ahead of your mortgage), sometimes debts to a homeowner’s association, income tax and child/spousal support liens, sometimes judgment and utility liens, and possibly construction liens for any home renovation or repairs.
With many of the kinds of secured debt owed by consumers, the collateral secures only one debt. You generally owe only one vehicle lender secured by your vehicle, for example. As you can see from the list at the end of the paragraph just above, that’s often not true of your home. You can owe a string of creditors secured by your home.
What if your home is worth less than the various creditors that are secured by your home? Are all of them really secured by your home when the home is not worth enough to cover all that debt?
Turning a Secured Second Mortgage into an Unsecured Debt
Chapter 13 enables you to turn your second mortgage into an unsecured debt if your home is worth less than the debts legally ahead of that second mortgage on your home’s title. The law effectively acknowledges that all of your home’s value is eaten up by liens that are ahead of the second mortgage, leaving no equity at all for that debt, making it an unsecured debt.
For example, if your home is worth $200,000, you are $2,000 behind in property taxes, owe $205,000 on your first mortgage, and owe $50,000 on your second mortgage, because the taxes plus first mortgage is more than the home’s value ($207,000 vs. $200,000), through Chapter 13 you could “strip” the $50,000 second mortgage off your home’s title.
Turning a Secured Third Mortgage into an Unsecured Debt
This works with a third mortgage as well, if you have one. If your home is worth no more than the debts legally ahead of that third mortgage—usually any past-due property taxes, the first mortgage balance plus the second mortgage balance—through Chapter 13 you could “strip” that third mortgage off your home’s title.
For example, if your home is worth $250,000, you are $2,000 behind in property taxes, owe $205,000 on your first mortgage and $50,000 on your second mortgage, and also have a $15,000 third mortgage, because the taxes plus the first and second mortgages are more than the home’s value ($257,000 vs. $250,000), the $15,000 third mortgage can be turned into an unsecured debt.
What Happens to the Stripped Second or Third Mortgage Debt?
As long as the court determines that indeed the home is not worth enough to secure ANY PORTION of the second or third mortgage being stripped, you do not have to pay that monthly mortgage any longer. You don’t have to catch up if you’re behind. The debt that had been secured by that mortgage is treated like any other unsecured debt under Chapter 13. It is lumped in together with your other unsecured debts—medical bills, credit cards, unsecured personal loans, and such—and these are all only paid as much as you can afford to pay on this lowest priority category of debts during the three to five years that your case lasts. Since often much of your available income is needed to catch up on your first mortgage, pay income taxes, and maintain your vehicle payments, often the unsecured creditors—including what you owe on the stripped mortgage—are paid only pennies on the dollars.
Then at the end of your successful Chapter 13 case, the second or third mortgage (and sometimes both) lien is permanently taken off your title, and whatever you owed and didn’t pay through the case is permanently written off. You’ve not needed to sell your home out of desperation, and you’re a lot closer to building equity in it again.