BANKRUPTCY AND THE SECOND MORTGAGE


If you have a second mortgage on your home and you file for Chapter 13 bankruptcy, you may be able to discharge or avoid paying the second mortgage. The fancy legal name for this process is ‘lien stripping’. If you are considering bankruptcy you should ask your attorney about stripping the second mortgage. Here is how it works. When you file for Chapter 13 bankruptcy, or what used to be called Debtor’s Court, the bankruptcy Trustee takes all of your debt and divides it into different categories; priority – debts that you cannot discharge in bankruptcy like taxes, secured – any debt that is secured by an asset like your house or your car, unsecured – most other debts like credit cards and payday loans. Priority debts must be paid in full, while you usually only pay a percentage of unsecured debts. Secured debts are a different story. In a chapter 13 bankruptcy, you are only required to pay back the value of a secured loan. For example let’s say that you owe $250,000.00 on your house. You owe $200,000 on the first mortgage and $50,000 on the second mortgage (or home equity line of credit). But the housing market has crashed and now your house is only worth $150,000. Since the value of your house is less than the first mortgage, the second mortgage is “wholly unsecured” and can be treated as an unsecured debt in your bankruptcy, meaning that you only pay a percentage of it back. Of course there are some caveats. If the value of your house is $200,000 plus one penny, then you can’t strip the second mortgage. It only works if the value of your home is less than the first mortgage.

Lien stripping is becoming more common in this housing market. If you are considering bankruptcy and you believe that your house is worth less than your first mortgage, you should talk to your bankruptcy attorney about stripping your second mortgage.