Stripping Mortgages in Bankruptcy
There are instances when borrowers have liabilities on their real estate that exceed its market value. In such cases, the second mortgage may become unsecured due to the lack of equity in the property.
When debtors want to keep property associated with an unsecured loan, the attorney may attempt to strip the mortgage lien. Lien stripping involves the complete elimination of a lien (loan), and the associated liability that goes with it.
MORTGAGE STRIPPING EXAMPLE
The debtors purchased a proptery for $400,000, but the real estate market has seen a significant drop, resulting in the value of the property dropping to $300.000. The debtors want to keep the property though, so that they can remain close to extended family, as well as to keep their kids in the same schools they have been attending.
There were two mortgages on the property:
- First Mortgage Balance: $300,000
- Second Mortgage Balance: $100,000
In the years after the mortgage crisis following the subprime mortgage meltdown, it was common that property values experienced a substantial drop, as property values had been inflated beyond their true worth.
In this scenario, the debtors have a liability of $100,000 over the market value of their property, causing the second mortgage to be 100% unsecured.
Utilizing the process of mortgage stripping, the wholly unsecured second mortgage would be entirely removed, resulting in the debtors being responsible only for the $300,000 that the property is valued at, and secured by the first mortgage, allowing them to continue to make payments to the lien holder of the first mortgage.
Currently mortgage lien stripping is only an option in Chapter 13 bankruptcy, and primarily used to strip wholly unsecured second mortgages.
Lien stripping is not permitted for removal of a second mortgage if it would lead to creating of equity in the property for the debtor(s). The mortgage lien being stripped must be entirely unsecured. Should the lien not be wholly unsecured, a cram down may be a viable option to consider.
Courts do not all agree on the proper method for stripping a mortgage lien. Most courts prefer that the debtor(s) address the lien stripping in their Chapter 13 Plan, or to file a Motion to Avoid Lien to formally ask the court to strip the lien. A few courts require debtors to bring an adversary proceeding, in order to strip a lien.
If you need a Motion to Avoid Lien, this is included in our Chapter 7 and Chapter 7 and 13 bankruptcy mastery courses.
When an attorney seeks to eliminate a lien for clients that you are drafting the bankruptcy petition for, they will provide you with guidance on the necessary modifications or adjustments to be made in the bankruptcy petition.
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