If you own a home with a qualifying 2nd or 3rd mortgage, one of the best reasons to file a Chapter 13 case is to “strip” off that mortgage.
Chapter 13 can help you keep your home in many powerful ways. Of those “stripping” a second or third mortgage can likely save you the most money. If you qualify, you can stop paying that mortgage immediately. And it can save you a tremendous amount of money in the long run.
Second or Third Mortgage Under Chapter 7 “Straight Bankruptcy”
If you file a Chapter 7 case you are not able to “strip” a mortgage. You simply have to pay any second and third mortgages on your home or lose the home. The mortgage is a lien on your home, so you have to pay it or the mortgage lender will foreclose on your home.
If your home is worth less than the combined balances of your first and second mortgages you may be able to sell your home through a “short sale.” In this situation the second mortgage lender accepts less than its full balance when you sell the home. But you may be left owing the balance. And in any event, this is not a way to keep your home.
The Chapter 13 Mortgage “Strip”
Only Chapter 13 gives you the possibility of “stripping” that junior mortgage lien off your home’s title. The key factor in qualifying is your home’s value. A second mortgage can be stripped from the home’s title if ALL of the home’s value is encumbered by liens that come ahead of the second mortgage lien on the home’s title. All of the home’s equity is taken up by the prior liens, leaving no equity for that second mortgage.
Under this situation the second mortgage debt is effectively unsecured. What’s special about Chapter 13 is that it provides a way for a court to declare this debt to be unsecured debt. Then that second (or third) mortgage is treated accordingly.
This means that in your Chapter 13 plan you no longer have to make your monthly payments on that mortgage. Instead, during life of your payment plan you pay it only as much as you can afford to pay. This means other special debts can be paid in full before that stripped mortgage debt receives anything. The mortgage balance is lumped in with all your other low-priority “general unsecured” debts. This usually means that you pay only pennies on the dollar on that mortgage debt. Then no matter how long you were contracted to pay that mortgage, at the end of the 3-to-5-year Chapter 13 case the unpaid portion is permanently written off. Your home gets much closer to having future equity through stripping away that second or third mortgage.
Here’s an example to show how this powerful tool works.
Assume that you’ve owned a home for 10 years now worth $300,000. It lost a lot of value during the “Great Recession” of 2008-2010 and hasn’t gained it all back yet. You owe a first mortgage of $310,000 and a second mortgage of $20,000. The second mortgage has monthly payments of $325, with a bit more than 8 years to pay on it. It has a high interest rate of 8%—your credit wasn’t the best when you got this second mortgage loan.
Let’s also say that you were unemployed for several months and so you fell behind on both mortgages. You are thousands of dollars behind. You also fell behind on other debts. You have found a new job but it doesn’t pay as well as the earlier one. So you need relief from your debts and need help in preventing your home from being foreclosed.
You really want to keep your home instead of walking away from it. It’s been the family home for a long time. It’s close to your new job, and to the schools your kids have been going to. Home and apartment rents are rising in your area, so any other housing would be expensive. Mortgage qualifying standards are tighter now than they were before the Great Recession. So you know that it would be quite a while before you could buy a home again.
So you need a Chapter 13 “adjustment of debts” to catch up on your home obligations and to deal with your other debts.
“Stripping” Your Second Mortgage
In this scenario you’d be able to “strip” your $20,000 second mortgage off your home’s title through Chapter 13. Your bankruptcy lawyer would file a motion in the bankruptcy court to do so. Those papers would show that the home’s value—$300,000—is less than the amount of the first mortgage—$310,000. So all of the home’s equity is fully taken up by this first mortgage lien, which is legally ahead of the second mortgage. So the bankruptcy judge would declare the second mortgage lien to be “stripped” off your home’s title. Then the debt you owe on the second mortgage—the $20,000—would be treated as an unsecured debt.
The Great Results
As a result:
- You could immediately stop making the $325 monthly payments. This would make it that much easier for you to pay the monthly payments on the first mortgage.
- You would not need to catch up on the second mortgage late payments. So during your Chapter 13 case you could concentrate on catching up on your first mortgage. If behind on 6 payments of $325 on your second mortgage, that’s $1,950 you would not have to pay.
- Your now-unsecured $20,000 second mortgage balance is treated like any other unsecured debt. So you’d pay it only as much as you could afford to during the 3-to-5-year life of the plan. In most plans there is only a certain amount available to pay all unsecured creditors. So, adding the second mortgage balance often doesn’t increase what you pay into your payment plan.
- When you get to the end of your Chapter 13 case the entire unpaid second mortgage balance is “discharged.” It is legally written off. The resulting savings would be substantially more than the $20,000 present balance. That’s because of the substantial amount of otherwise accruing interest that you would also avoid paying.
- Stripping the second mortgage off your home’s title would get you substantially closer to building equity in your home.