Lien Stripping of Second Mortgages in Chapter 13
One of the main reasons consumers file Chapter 13 bankruptcy is to save their homes from foreclosure. With Chapter 13, also known as a wage earner’s plan, the debtor may be able to keep the home by paying off mortgage arrearages over a period of years. However, a homeowner may have more than one loan secured by a mortgage on the same property, such as a second mortgage or home equity line of credit. In Chapter 13 bankruptcy, these junior mortgages may be removed based on a process known as lien stripping.
Mortgage liens are subject to payment priority. The rule is “first in time, first in right.” In a Chapter 13 bankruptcy, the holder of the first mortgage lien must be paid before a second lienholder is eligible for any repayment. Likewise, the second lienholder must be paid before a third mortgage lien. The party who holds the earliest recorded mortgage is called the first lienholder. Any subsequent lenders holding a mortgage are called junior lienholders. Subsequent lienholders are junior to all others ahead of them.
Lien stripping requires a comparison of the current fair market value of the home to the outstanding mortgage debts. Lenders do not make home loans if the value of the property is insufficient to cover the obligation. However, sometimes home values drop after the loans have been made. This is where lien stripping can be used in a Chapter 13 bankruptcy case.
A junior lien may be stripped — that is, invalidated — when the total amount of all other senior liens exceeds the home’s current value. For example, suppose that the debtor’s home is worth $250,000. The debtor also owes $250,000 to the first lienholder, and $50,000 on a second mortgage. The first lien is fully secured, but the junior lien is not. The junior lienholder’s mortgage can be stripped down. The debt does not disappear. It is converted to an unsecured obligation like a credit card or medical bill. However, in most cases, the homeowner will pay little or nothing on a stripped lien conversion and only the first mortgage arrearages will be repaid in bankruptcy.
The Law Offices of Michael Jay Berger in Beverly Hills is one of the largest bankruptcy practices in California. If you have a Chapter 13 case or creditor issue, feel free to contact us online or call 310-271-6223 to schedule an initial consultation.