A Second Mortgage “Strip” through Chapter 13
“Stripping” off a second mortgage has major immediate and long-term benefits.
In a blog post last week we listed 10 ways Chapter 13 helps you keep your home. Here’s the second one of those:
2. Stripping Second or Third Mortgage
Under Chapter 7 you simply have to pay any second (and third) mortgages on your home or lose the home. However, Chapter 13 gives you the possibility of “stripping” that junior mortgage lien off your home’s title. This could potentially save you hundreds of dollars monthly. You could also end up paying just a fraction of the entire balance, or sometimes paying none of it all. That could save you many thousands or even tens of thousands of dollars in the long run.
How do you qualify for this junior mortgage lien “stripping”? The key factor is your home’s value. The second mortgage can be “stripped” from the home’s title if the entire value of the home is fully encumbered by liens legally superior to the second mortgage lien. “Legally superior” liens are those liens ahead of the second mortgage lien on the title. All of the home’s equity is fully absorbed by liens ahead of it on the title. So the second mortgage debt is declared to be an unsecured debt, and is treated accordingly.
To bring this explanation to life let’s show how this incredible tool works by example.
Assume that your home is worth $200,000. It lost a lot of value during the “Great Recession” of 2008-2010 and hasn’t gained it back yet. You owe a first mortgage of $210,000 and a second mortgage of $18,000. The second mortgage has monthly payments of $250, 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.
Also assume that you were unemployed for a spell and so fell behind on both mortgages, as well as on other debts. You have a new job but it doesn’t pay as well as the earlier one, so you need help.
You very much want to keep your home. You’ve had it forever and it’s close to your new job. Home and apartment rents are rising in your area. You know that mortgage qualifying standards are tighter now than they were before the Great Recession. So for good reason you’re afraid that it would be a long time 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 $18,000 second mortgage off your home’s title through Chapter 13. Your bankruptcy lawyer would file special papers in the bankruptcy court to do so. Those papers would show that the home’s value—$200,000—is less than the amount of the first mortgage—$210,000. So all of the home’s equity is fully absorbed by the lien legally ahead of the second mortgage. As long as the bankruptcy judge accepts this to be true, he or she would declare the second mortgage lien to be “stripped” off your home’s title. Then the debt you owe on the second mortgage—the $18,000—would be treated as an unsecured debt.
The Great Benefits
A number of very good consequences would flow from this.
- You could immediately stop making the $250 monthly payments. This would make it easier for you to pay the first mortgage’s monthly payments.
- To the extent you were behind on the second mortgage, you would not need to catch up. This means that during your Chapter 13 case you could concentrate on catching up on your first mortgage. If behind on 6 payments of $250 on your second mortgage, that’s $1,500 you would not have to pay.
- Your now-unsecured $18,000 second mortgage balance is treated in your Chapter 13 payment plan just like any other unsecured debt. That is, 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. It’s not unusual for the second mortgage balance to be paid only a few pennies on the dollar. In fact, sometimes you pay NOTHING on that second mortgage balance (and on your other general unsecured debts).
- At the end of your successful Chapter 13 case the entire unpaid second mortgage balance is “discharged”—legally written off. Assume for a moment that your payment plan allowed you to pay nothing on this second mortgage balance. Realize that the resulting savings would be substantially more than the $18,000 present balance. That’s because of the substantial amount of otherwise accruing interest that you would also avoid paying. The $18,000 balance at 8% with $250 payments would take a little more than 8 years to pay off, thus including about $6,600 in interest you’d also avoid paying.
- Lastly, “stripping” the second mortgage off your home’s title would greatly improve your potential equity picture. Instead of owing $228,000 ($210,000 first mortgage + $18,000 on the second mortgage), you’d owe only $210,000. You’d be that much closer to building equity in your home as you paid down the first mortgage and as the home increases in value.