When it comes to bankruptcy, many clients question whether you can get rid of a second mortgage. Well in some cases you can through lien stripping which removes the second mortgage lien on your home. Read on for more information.
Section 506(a) of the Bankruptcy Code separates the debtor’s obligations into two general categories or commonly referred to as “claims”:
- secured claims and;
- unsecured claims
Secured claims are obligations in which payment of is guaranteed (or “backed” or “secured” or “collateralized”) by property. Section 506(a)(1) provides that a secured creditor’s claim is “a secured claim to the extent of the value of such creditor’s interest in the estate’s interest in such property . . . and is an unsecured claim to the extent that the value of such creditor’s interest . . . is less than the amount of such allowed claim.”
What this means is that when the value of the property is less than the amount of the secured claim, section 506(a) allows the obligation to be divided into a secured claim and an unsecured claim.
For instance, suppose you finance a car for $40,000; traditional wisdom states that the car depreciates the minute it drives off the lot, so let’s say the car is now worth $35,000 and no payment has been made. In bankruptcy this car loan would have a secured claim of $35,000 (the value of the collateral) and an unsecured claim of $5,000.
So why is dividing a debt into secured and unsecured claims important? It’s simple. While unsecured claims (i.e. the $5,000 in the above example) are discharged in bankruptcy, liens on secured claims (i.e. the remaining $35,000 in the above example) survive a bankruptcy discharge.
To give a little more clarity to the above example, the Bankruptcy Code contains many tricks to discharge the unsecured portion of a debt which reduces the amount that a debtor owes. For a lot of people in debt and going through a bankruptcy, this is great news!
Lien stripping a Junior Mortgage
The most notable prohibition against reducing the amount owed on a secured obligation is found in section 1322(b). This provision (often called the “anti-modification provision”) prohibits a Chapter 13 debtor from modifying the rights of a secured claim when the claim is secured only by the debtor’s principal residence.
The U.S. Supreme Court in the case of Nobelman v. American Savings Bank, 508 U.S. 324, 113 S. Ct. 2106 (1993), decided that 1322(b) meant that a claim against the debtor’s primary residence cannot be divided into secured and unsecured claims.
The most notable prohibition against reducing the amount owed on a secured obligation is found in section 1322(b). This provision, often called the “anti-modification provision,” prohibits a Chapter 13 debtor from modifying the rights of a secured claim when the claim is secured only by the debtor’s principal residence.
However, most bankruptcy courts have distinguished the ruling in Nobleman to allow a junior mortgage to be stripped away if the value of the senior claims are more than the value of the debtor’s home.
To understand how lien stripping works, consider the following example:
- Value of home: $330,000
- First mortgage: $360,000
- Second mortgage: $40,000
Most courts allow the $40,000 second mortgage to be stripped off and reclassified as an unsecured debt because the amount owed on the first mortgage is less than the value of the home.
In other words, the second mortgage is not actually secured by anything because the amount owed on the first mortgage “eats up” all of the home’s equity.
There is no equity left to secure the second mortgage.
If the second mortgage was partially secured, even by one dollar, the second mortgage could not be lien stripped according to Nobelman.
Lien stripping a home mortgage in Chapter 7
The U.S. Supreme Court held that lien stripping is not available to Chapter 7 debtors (Dewsnup v. Timm, 502 U.S. 410, 112 Sup. Ct. 773, 116 L. Ed.2d 903 (1992)).
For years bankruptcy courts have applied Dewsnup and held that section 506 may not be used to strip off wholly unsecured junior lien in Chapter 7. See Palomar v. First American Bank (In re Palomar), No. 12-3492 (7th Cir. July 11, 2013); Ryan v. Homecomings Fin. Network, 253 F.3d 778 (4th Cir. 2001); Talbert v. City Mortg. Serv., 344 F.3d 555 (6th Cir. 2003); Wachovia Mortg. v. Smoot, 478 B.R. 555 (E.D.N.Y. 2012).
However, a unanimous panel of the Eleventh Circuit Court of Appeals found Dewsnup to be irrelevant when applied to a junior mortgage that is entirely unsecured. In re McNeal, Appeal No. 11-11352, 2012 WL 1649853 (11th Cir. May 11, 2012).
Lien stripping of joint property
A hot bankruptcy topic in recent years is whether a bankruptcy court, in a Chapter 13 case filed by only one spouse, can strip off a valueless lien on property that the debtor and his non-debtor spouse own as tenants by the entirety.
Tenants by the entirety is a special kind of ownership for married couples and, in a few states, same-sex couples who have registered with the state.
Tenants by the entirety means that both tenants have the right to enjoy the entire property and neither one can unilaterally end the tenancy. Ownership as tenants by the entirety is currently recognized in some form in 26 states.
Stripping off a junior mortgage if only one spouse files bankruptcy has been considered by several bankruptcy courts with different conclusions.
If you have some extra time, you can compare “In re Hunter, 284 B.R. 806 (Bankr. E.D. Va. 2002)” (applying Pennsylvania law and concluding that an individual debtor spouse cannot strip off a lien on entireties property), and “In re Pierre, 468 B.R. 419 (Bankr. M.D. Fla. 2012)” (reaching same result under Florida law), and most recently with “In re Alvarez, No. 12-1156, 2013 WL 5737704 (4th Cir. Oct. 23, 2013)” (reaching same result under Maryland law), with, e.g., “In re Strausbough, 426 B.R. 243 (Bankr. E.D. Mich. 2010)” (applying Michigan law and determining that an individual debtor can strip a valueless lien on entireties property).