Discussion: Principle Reductions: Wipe Out Your 2nd Mortgage With Bankruptcy

[Moe Bedard]

Welcome to our new project on discussing important issues and foreclosure defense tools that homeowners can use to fight their lender or save their homes.

Today's Discussion Blog Post:

Principle Reductions: Wipe Out Your 2nd Mortgage With Bankruptcy

Millions of American homeowners are now underwater on their home mortgages and they are looking for a way out. In some areas like the Inland Empire of California, local homeowners have seen values drop 30-50% and many are making a “business” decision to walk away without ever exploring ways to save their home.

If you have decided to walk away from your home and think you have no other options but to bail on your underwater house, you may want to read this.

Wouldn’t it be much easier to save your home if you only had a first mortgage and no other payments? What if you could effectively wipe out $50,000, $100,000 or $200,000 of what you owe on your mortgage? Also, if the market turns around, think of all the equity you would build back up years from now?

For homeowners who have taken out a second mortgage on their home, facing financial difficulties can be particularly challenging. In most cases, a 2nd mortgage reduces your home equity to a very small amount, leaving you vulnerable to the whims of your lenders. In cases where real estate values have declined, as we are seeing in most markets today, there are strategies that you can use to protect yourself from excessive debt.

Current bankruptcy law allows judges to approve the loan modifications of the terms of certain debts, namely auto and student loans and second-home mortgages. In the case of second mortgages, if the value of the property falls below the loan amount, debtors potentially could reduce the balance of the loan to equal the current value of the property.

If the courts remove this 2nd mortgage, this is known as “stripping” the lien, “cram down” or “strip down,” which can also occur if the loan is secured by other collateral that is part of the filing or if the home is not your principal residence, or even if the payment structure on the 2nd mortgage falls heavily during the bankruptcy filing itself.

Lien Stripping Example:

• Home is worth $200,000.
• The first mortgage is for $200,000.
• A second mortgage (or in certain states, a deed of trust) for $100,000.
• Lenders are only secured up to the value of the property and in this case the first lender is under secured by $100,000 because the value is $200k and is $100k "underwater."
• The value of the property is less than the lien by $100,000.
• The second lender has nothing securing their lien because they are unsecured because the property has no value left over from the first lien.
• They are treated as an unsecured creditor.
• Most likely the second lender will not be able to collect on the mortgage after the bankruptcy discharge and the homeowners (debtors) still get to keep the house.
• The homeowner would not even have to pay the lien when they sell the house.

Now, THAT IS POWERFUL tool for homeowners who have second mortgages and are underwater!

Read the rest of Principle Reductions: Wipe Out Your 2nd Mortgage With Bankruptcy and please join the discussion below.

[ryma9295]

Hello we recently had a loan mod. approved with Wells Fargo and received alot of support through this site with that. The loan mod. took care of the first mortgage only. Our problem is the second with Bank of America. They wouldn't modify it a few months back because we haven't made enough payments on it and need to be current. We haven't made a payment on it since Feb. 2008. It is a HELOC loan and the amount is approx. $ 125,000. The first mortgage is a balance of approx. $ 342,000. The value of our home is around $ 320,000. I went to see a bankruptcy attorney in my hometown in Viriginia to see about this issue I have and he told me he has heard of lien stripping from an attorney in another city in Virginia that has been doing it and will let me know what he finds out after talking to him. I have our unsecured debt in a settlement program and that is going fairly smoothly and getting ready to settle our second account. Right now the only reason to file bankruptcy would be for the second mortgage we have but waiting to see what the attorney says concerning stripping the lien. It's a huge amount and really has me worried. So far bank of America has stopped making the calls to us since August 2008. Seems they aren't sure what to do either and so nothing is being done at this point.

[Moe Bedard]

I would point your lawyer to these sections of the Bankruptcy code.

Section 506 of the Bankruptcy Code acknowledges that a lien is only a secured claim to the extent there is value in the asset to which it attaches. To the extent that the claim exceeds the value of the collateral, that portion of the claim is unsecured.

Within Chapter 13 Bankruptcy law, section 11 USC 1322 can potentially allow you to forgo your second mortgage, under certain circumstances. If your second lien on the whole is unsecured, then when the value of your home drops belong the first mortgage deed of trust, the second becomes wholly under secure, which can be negated through a Chapter 13 filing.

[jhn_plsn]

This helps me make my decision to go forward with my BK. If I can include the 2nd with the other debts I could then deal only with the 1st to then stabalize my situation. I have been so depressed about this that I am almost dissfunctional. My eyes lit up when I read this, but will see what the lawyer has to say.

[Moe Bedard]

I know this can be frustrating and dealing with lawyers can be equally frustrating. So, just make sure that your attorney looks into this because this is a new approach that not many attorneys have used in the BK process.

Maybe it will be you who educates him.

Above all, keep fighting the good fight and square up those shoulders every day because this time will pass and you will learn from this.

[revcarrie]

Moe, I'm running all over in here simply because I can't sleep because of the excitemnt over our own modification. I am AMAZED everytime I go into a new area. Your help and knowledge is amazing! Isn't it nice when you find your calling in life and then get a chance to do it? Congrats and thanks.
Rev. Carrie

[jhn_plsn]

Originally Posted by revcarrie

Moe, I'm running all over in here simply because I can't sleep because of the excitemnt over our own modification. I am AMAZED everytime I go into a new area. Your help and knowledge is amazing! Isn't it nice when you find your calling in life and then get a chance to do it? Congrats and thanks.
Rev. Carrie

Here, here. Although I am scared to death and have been putting my head in the sand I now see some light.
Thank you all who have contributed and as my situation changes for the good or bad I will also post here.
Moe, I fear the attorney for my BK may not be familiar with this new tactic but if they are not willing to hear me out then I guess someone else gets my very hard to come by money. If I have to sacrifice a little now in going rounds with a lawyer to set us up for the future then so be it.

[wags1022]

Hello, I am very interested in this since we should have never had a second mortgage to begin with. Our home value is $330,000 down from $400,000 2 years ago. We owe $305,000 on the first loan with Litton (who did modify) and the 2nd with Wilshire a interest only balloon note. I am not sure where in Va you live but we too are from Va. I will be looking for BK attys in our area. I suspect we will have to go to Richmond. Good luck !

[anywho]

Excellent info, Moe!

Question: Can this pricple reduction technique be utilized if someone files a Chapter 7 BK instead of a Chapter 13? You have quoted the Chapter 13 BK law, so this is why I ask. Would this be because the Chapter 13 allows for 'reorganization'?

One more Q: If the value of the property is established as being more than the amount of the 1st lien, but the appraised value above the 1st lien is relatively nominal in relation to the balance owed on the 2nd lien; would the Judge possibly not dismiss the 2nd lien entirely and just reduce the amount owed to the difference between the appraised value and 1st lien balance?

In my case, I owe $165k on the 1st, but have a 2nd (used for an uncompleted remodel) that is $175k. The tricky part is that the house still needs another $30 to $50k to finish the remodel, and I'm not sure how the value would be effected by the currrent 'distressed' condition. The house was appraised at $475k when the current refi was done two years ago, but prices in the neighborhood have fallen to $275k or less now. Conversations with a couple of real estate professionals have suggested my house might sell at auction for something like $150 to $175k.

If I could work out something to reduce the 2nd to nothing (or nearly so) and keep the first as is, it would be worth it to me to work on finishing the remodel over the next few years; as finances permit, and with me living in the middle of a construction site. I'm currently 60 days behind on both mortgages. Should I try to see if I can catch up on the 1st and continue not paying on the 2nd, or should I just not pay on both and let the judge handle dealing with that?

Thank you in advance.

[anywho]

TTT for Moe.

[Moe Bedard]

anywho.............

Here is an article that answers your question..................

As with all legal questions, the answer is it depends. While the Supreme Court has ruled that you can not strip a second mortgage in a Chapter 7 proceeding, you still may be able to file a subsequent Chapter 13 case to achieve the goal.

So the issue really depends upon whether you can qualify for Chapter 13 relief and whether such plan is proposed in good faith.


This “double bankruptcy” is often referred to as a Chapter 20, which essentially is a Chapter 7 followed by a Chapter 13. Unfortunately, a Chapter 20 usually brings up issues of bad faith and Bankruptcy Courts highly scrutinize these filings. Lien stripping in the subsequent Chapter 13 case entails both qualifying for Chapter 13 relief and qualifying for lien stripping within that chapter.

To strip a second or junior mortgage on the personal residence in the subsequent Chapter 13 requires proving Chapter 13 eligibility (you have income and are within the debt limitations) and that the lien is totally unsecured (the value of the house is less than the first mortgage debt).

Most issues arise over whether the subsequent filing was done in good faith or not. Bad Faith frequently arises when individuals attempt to take advantage of both chapters where such advantages are not typically available in either chapter. For instance, filing a Chapter 7 to remove the unsecured debt for a later Chapter 13 solely in an attempt to reduce the Chapter 13 payments due to the lower debt load, is often viewed as bad faith.


On the other hand, reducing the unsecured debt in a prior chapter 7 case in an effort to qualify under the debt limits in the later Chapter 13 case, thus saving the fees, costs, and requirements in avoiding a Chapter 11 case, is generally considered not bad faith. Its a very fine line, but very important distinction between reducing monthly payments and reducing debt to qualify.


By the same token, the sudden drop in real estate values after the filing of a chapter 7(wherein one would not have qualified for lien stripping with previous values), which makes lien stripping a possibility now, would also be considered in good faith.


So what then gets paid in the subsequent Chapter 13 since all debt was previously discharged? Courts continue to struggle with this dilemma in Chapter 20 cases. On the one hand, there is no longer any unsecured debt due to the previous discharge under 11 USC 524. So technically, when the Chapter 13 is filed, the only debts that might remain are secured debts, taxes, student loans, non-dischargeable debt, other priority debt, and post chapter 7 debt. But assuming none of this other debt remains and the only purpose of the Chapter 13 is to strip the lien, does anything get paid?


The majority of Courts are now holding that while the secured lien is now voided and the debtor no longer personally owes any of the debt, a new unsecured debt is still created. Even though the prior Chapter 7 discharged this debt as a personal liability of the debtor and it can not be collected against the debtor personally, it is an unsecured debt that can be collected against the Chapter 13 estate. As such, most Bankruptcy Courts are now allowing these unsecured claims to be paid over a 3 to 5 year plan, even though the debtor no longer personally owes it.


So what then happens on discharge? Since under the new bankruptcy laws, a chapter 13 will not receive any discharge if filed within 4 years of a chapter 7, does the debtor now personally owe a huge unsecured debt upon completion of their chapter 13? No, as previously stated, since the debt has already been discharged in the previous chapter 7, the debtor no longer personally owes the new unsecured debt, even though there will be no discharge of this new unsecured debt in the subsequent chapter 13 case.


Finally, there is also no Code provision that requires that a lien may be stripped only upon Chapter 13 discharge. In fact, the Code provisions that are used, 11 USC 506(d) and 11 USC 1322, each provide that the lien stripping is immediate, even if no discharge and even prior to completion of all chapter 13 payments. Moreover, since the new Bankruptcy Laws under 11 USC 348 and 11 USC 349 provide remedies in the event of dismissal or conversion, new arguments can be made for immediate recording of the avoided lien.

In short, a prior chapter 7 should not be an obstacle for a subsequent chapter 13 that is filed to strip a junior mortgage, provided the requirements for lien stripping exists and there is no bad faith in that chapter 13 filing. Always check with an experienced Bankruptcy Attorney if you think you might qualify for this relief.

[anywho]

Thank you very much, ***. Very good information to consider with regard to my question on BKs. Would still like to get some input on my other question on lien stripping and whether it needs to be an all-or-nothing proposition, or whether a Judge could simply reduce the amount owed (on the 2nd) to the difference between the balance owed on the 1st and the appraised value? Given the difficulty of assigning a value to home such as mine, I would also be interested to learn what is the accepted method of valuing a property for purposss of presenting your cass to a BK Judge?

[cathyvr]

Hi.Discussions here has been very informative. I hope somebody can give me some ideas on how best to approach our situation. Our current loan is $800,000 (1st with Saxon Mortgage for $650,000; 2nd with Citibank 150,000). Both loans are in my husband's name only. Our house is currently valued at $550,000 - $600,000. We consulted a lawyer and he recommended a joint Chapter 7 filing to wipe out our 2nd loan and our cc debts. Here's the problem, I just opened a business early this year and is still in the process of opening accounts with vendors. The business is not yet booming but is surviving and it has potential to grow (I hope... but with this economy its really hard to tell). The business is registered in my name only. We do not have combined credit cards. We always apply cards in separate names. My questions is: is it possible for my husband to file for bankruptcy and not me. What other options do we have to wipe out our 2nd loan? Or should we just let go of our house? We haven't made any payments in our house since June. We have not had any forclosure notices yet but I think its coming soon. I am not sure if our lawyer really knows what he's doing, so I am trying to research about the subject myself and get myself educated. Any ideas, insights will help a lot. Thanks.

[LenderNoHelp]

Moe,

Lien Stripping sounds great but, in reality it doesn't really get extinguished right? Only reorganized under Chapter 13 repayment plan? Please advise.

[mtg2008]

if my first mortgage balance is $357K, 2nd is $240K, the house vaule is $450K. It that mean I will not be able to qualify for BK to get rid of the 2nd mortgage? Or the judgement may order priciple reduction on the 2nd to somewhere $100K ? Please advise. Thanks.

[Moe Bedard]

OK, let me first disclose that I am not an attorney and this information is found on the internet and based on my own personal research which has been known to be pretty darn good

This area of BK law is often never explored, nor do many attorneys have the experience to comment or knowledge to pursue a lien strip on a 2nd. I am CERTAINLY not an expert.

My goal is to open peoples minds with my posts by finding information and laws that can be then explored by a qualified legal professional or for a homeowner to further explore or for us to do like we are now and maybe one of you will find the right lawyer or evidence to pursue this and be successful.

Nothing in this area of law appears to be slam dunk and especially since the legal water have been traveled by a minute few.

Never take my forum or blog pots as financial saving gold. But as information you can use to further explore.

With that said, I feel it all comes down to how this 2nd stands, was originated, how the money was used from the money of the 2nd. Was $200k taken out to fund a lavish lifestyle of vacation and Guci bags or for real economy spending such as a business or home improvements (reasonable).

This is from the original blog post:

In Chapter 11 or Chapter 13, even voluntary liens, such as mortgages and security interests, can be stripped down to the value of the collateral, with the exception of voluntary liens secured only by the debtor’s residence. Congress is currently considering changes to bankruptcy law allowing the modification of home mortgages.


Despite the general rule, two exceptions may apply so as to allow lien stripping of a mortgage on a personal residence:


Loans based on a home plus other collateral. Lien stripping is prevented only when the lien is secured “solely” by a personal residence. Court decisions have made it clear that when the debtor has given other collateral (in addition to the personal residence; e.g., office equipment) as security for the mortgage, lien stripping will be allowed. Thus, if you will be taking out a second mortgage or refinancing your home, you should consider offering additional collateral, such as furniture, as security for the loan. This can be done under the guise of seeking better terms from the lender, such as a lower interest rate.


Some second mortgages. Many (but not all) bankruptcy courts follow a rule that makes a second mortgage totally unsecured if the first mortgage balance equals or exceeds the value of the personal residence. This exception will not apply in the case of a refinancing of a mortgage, since in a refinancing the new mortgage pays off the first mortgage. The exception is predicated on there being two distinct mortgages (a first and a second mortgage). For this reason, if you have the option of financing your business through a second mortgage or refinancing your first mortgage, the second mortgage may be the better choice, especially where the amount of the first mortgage is close to the value of the home.


In addition, remember that the general rule applies only to a lien secured solely by a personal residence. Thus, lien stripping will be allowed for a mortgage on a building used in a business.


While there is no assurance of how the courts will decide, depending on the terms of the original loans as well as the details of your filing, there are options for home owners with multiple liens on their home. This is because most additionally mortgages are unsecured for the loan, especially in the context of depressed home values.

Principle Reductions: Wipe Out Your 2nd Mortgage With Bankruptcy | Home Mortgage Forum | Protect Your Home & Mortgage With Loan Safe

[LenderNoHelp]

Moe,

Two loans were used to purchase my home. 1st mortgage with CW at 584K 6.75% 30 years fixed I/O and 2nd mortgage with Select Portfolio Servicing 110K Adv Second 30/15 Piggyback at 9.975%. I have 15 years to pay 110k and I wasn't aware of that at that time. Purchase price of home was 730K. Market value maybe 500K. Is it even worth going for lienstripping? I am at a point where, I do not know which route to take. Please advise.

[Moe Bedard]

Hey Jenny,

Are you in California? If so, then So your first and second mortgage if it has NOT been refinanced is a non-recourse loan. Why? Because it was purchase money for your home. In California purchase money loans made on your primary residence are non-recourse.

Here are some great links and info from About.com for you on non-recourse loans.

A non-recourse loan does not allow the lender to pursue you after foreclosure for anything other than your property. If you just walk away, your lender can only foreclose on the home. They cannot take further legal actions against you.


You should consult your attorney or tax adviser be certain whether you have a recourse loan or a non-recourse loan.

California is a non-recourse loan state that makes it hard for lenders to sue. Other states allow lenders to sue but many dont because they don’t have much to go after.

• List of State Laws on Recourse Loans

Look up your state and see your state's rules on deficiency judgments.

[NeedHelpwCW]

Hi Moe,

I want to confirm that I have non-recourse loans. I am in California. My 1st is with CW and was taken out at the time of purchase. Shortly after the purchase, I obtained a 2nd with Citi (HELOC) for home modifications. I have not refinanced these loans. Since I have not refi these loans, does it mean that I have non-recourse loans?

The loan amounts are $721k with CW and $110k with Citi. The value of the property is estimated to be $690k. Would filing for BK strip the 2nd with Citi? WOuld like also lower the 1st with CW to $690k?

Please help. Thanks!

[bentley31]

Hi Moe,

Here is my situation any help will be greatly appreciated. I have 3 properties in total. First is my primary. I purchased the home approx. 18 months ago for $630,000 I am currentley 4 months behind on my mortgage. The home is valued at $485,000 and the loan is through Wells Fargo with the help of guy named Dan Harris I have sent in all docs for a loan mod with the hopes to save my home. My 2nd property is a rental property valued at approx. $390,000 the first is with countrywide $375,000 and the second with WAMU $175,000. The third is worth $300,000. The first is with IndyMac $368,000 and the second WAMU $70,000 and I am 7 months behind on both properties. Here was my plan I was going to hold on to my primary, let the two other properties go to foreclosure and then file for a Chapter 7. After I started reading your discussions I thought it would be best to hold on to all the properties and try and wipe out the seconds on the investment properties and try to cram down the principal on my primary. Is this possible to be done through bankruptcy? Your help is greatly appreciated. I am located in New Jersey.

[jms1972]

We have two mortgages on our home 1st mortgage 153K. and 2nd mortgage 35K. Our home now is about 145K-150K. We filed chapter 7 bankrupcy about two years ago and both mortgages were discarged in the BK. We would like to get rid of 2nd mortgage our home isn't worth 188K anymore. So would or could we now file chapter 13 to strip the lien of mortgage 2 or what could be our other options to get rid of the 2nd mortgage.
JMS

[Moe Bedard]

You would need to discuss this with the attorney...........the thread is for informational purpose to enlighten members as to what is happening in the realm of bk and what may be possible.

[desmar9]

Does anyone know if the lien stripping can be done in Massachusetts? Or has it been done in this state so far?

[LostSoul]

Originally Posted by *** Damiano

anywho.............

Here is an article that answers your question..................

As with all legal questions, the answer is it depends. While the Supreme Court has ruled that you can not strip a second mortgage in a Chapter 7 proceeding, you still may be able to file a subsequent Chapter 13 case to achieve the goal.

So the issue really depends upon whether you can qualify for Chapter 13 relief and whether such plan is proposed in good faith.


This “double bankruptcy” is often referred to as a Chapter 20, which essentially is a Chapter 7 followed by a Chapter 13. Unfortunately, a Chapter 20 usually brings up issues of bad faith and Bankruptcy Courts highly scrutinize these filings. Lien stripping in the subsequent Chapter 13 case entails both qualifying for Chapter 13 relief and qualifying for lien stripping within that chapter.

To strip a second or junior mortgage on the personal residence in the subsequent Chapter 13 requires proving Chapter 13 eligibility (you have income and are within the debt limitations) and that the lien is totally unsecured (the value of the house is less than the first mortgage debt).

Most issues arise over whether the subsequent filing was done in good faith or not. Bad Faith frequently arises when individuals attempt to take advantage of both chapters where such advantages are not typically available in either chapter. For instance, filing a Chapter 7 to remove the unsecured debt for a later Chapter 13 solely in an attempt to reduce the Chapter 13 payments due to the lower debt load, is often viewed as bad faith.


On the other hand, reducing the unsecured debt in a prior chapter 7 case in an effort to qualify under the debt limits in the later Chapter 13 case, thus saving the fees, costs, and requirements in avoiding a Chapter 11 case, is generally considered not bad faith. Its a very fine line, but very important distinction between reducing monthly payments and reducing debt to qualify.


By the same token, the sudden drop in real estate values after the filing of a chapter 7(wherein one would not have qualified for lien stripping with previous values), which makes lien stripping a possibility now, would also be considered in good faith.


So what then gets paid in the subsequent Chapter 13 since all debt was previously discharged? Courts continue to struggle with this dilemma in Chapter 20 cases. On the one hand, there is no longer any unsecured debt due to the previous discharge under 11 USC 524. So technically, when the Chapter 13 is filed, the only debts that might remain are secured debts, taxes, student loans, non-dischargeable debt, other priority debt, and post chapter 7 debt. But assuming none of this other debt remains and the only purpose of the Chapter 13 is to strip the lien, does anything get paid?


The majority of Courts are now holding that while the secured lien is now voided and the debtor no longer personally owes any of the debt, a new unsecured debt is still created. Even though the prior Chapter 7 discharged this debt as a personal liability of the debtor and it can not be collected against the debtor personally, it is an unsecured debt that can be collected against the Chapter 13 estate. As such, most Bankruptcy Courts are now allowing these unsecured claims to be paid over a 3 to 5 year plan, even though the debtor no longer personally owes it.


So what then happens on discharge? Since under the new bankruptcy laws, a chapter 13 will not receive any discharge if filed within 4 years of a chapter 7, does the debtor now personally owe a huge unsecured debt upon completion of their chapter 13? No, as previously stated, since the debt has already been discharged in the previous chapter 7, the debtor no longer personally owes the new unsecured debt, even though there will be no discharge of this new unsecured debt in the subsequent chapter 13 case.


Finally, there is also no Code provision that requires that a lien may be stripped only upon Chapter 13 discharge. In fact, the Code provisions that are used, 11 USC 506(d) and 11 USC 1322, each provide that the lien stripping is immediate, even if no discharge and even prior to completion of all chapter 13 payments. Moreover, since the new Bankruptcy Laws under 11 USC 348 and 11 USC 349 provide remedies in the event of dismissal or conversion, new arguments can be made for immediate recording of the avoided lien.

In short, a prior chapter 7 should not be an obstacle for a subsequent chapter 13 that is filed to strip a junior mortgage, provided the requirements for lien stripping exists and there is no bad faith in that chapter 13 filing. Always check with an experienced Bankruptcy Attorney if you think you might qualify for this relief.

***,
Thank you for all the information you are providing via this site. I am in No. California and are exploring BK in Chapter 7 due to our high debt level. Your post was very interesting concerning Chap 7 filing and then filing Chap 13 hofefully to strip the 2nd mortgage. Here's our situation:
1st Mortgage/Held by Chase $564,000
2nd Mortgage/Held by Chase $140,000
We have leveraged everything to keep both mortgages current so far.
House appraised by realtor from our area - $450-$460,000 which puts us under water by approx $244,000. Per your post it would seem my 2nd mortgage should be completely unsercured at this point and may be able to be strip under a Ch 13 filing; possibly creating a Chap 20 condition. I relayed this to my lawyer and he seems to feel Chap 20 filings aren't available anymore in Calif since 2005. Is there anyway I can find that out for sure? If so after I file Ch 7 am I then stuck with the 2nd even though it's unsecured? And if that is the case should I prepare to walk away and take the hit?

[Moe Bedard]

HI LostSoul,

welcome to the forum and thank you for joining.................

If I were you, I would consult with a couple of BK attorneys, until you feel comfortable moving forward........especially if you feel that this attorney doesn't seem very knowledgable..........the consults are usually free.............this is just information that I googled..........you can do the same for an answer to the question about the Chapter 20 BK in California...........