A judgment lien turns an unsecured debt into one secured by a lien on your home. Bankruptcy can undo that, and write off the debt.
Very Different Treatment of Unsecured Debts and Secured Debts
A couple blog posts ago we discussed how differently unsecured and secured debts are treated in bankruptcy.
Most debts that do not have a “lien” on any of your property or possessions are legally, permanently written off in bankruptcy. However with secured debts the lien that the creditor has in your asset is NOT USUALLY written off or affected in any way in bankruptcy. That means the creditor can take collection action against your asset through that lien after the bankruptcy case is completed. As a result usually you have to pay the debt.
But in certain situations bankruptcy CAN turn a secured debt back into an unsecured debt. We focus on another one of those situations today.
Erase a Lien in Bankruptcy is Extraordinary
It’s important to realize how extraordinary it is to be able to turn a secured debt into an unsecured one. It’s unusual even in bankruptcy. Most liens cannot be erased. Instead, after bankruptcy they often have to be paid either in full or in part.
So it’s quite special to be able to erase a judgment lien, write off the debt, and not pay anything.
Erasing a Judgment Lien
But this can only be done under certain circumstances. The good news is that for practical reason these circumstances apply to a large percentage of people filing bankruptcy who have a judgment lien on their home.
In order to get rid of a judgment lien, the liens must “impair your homestead exemption.” (See Section 522(f) of the Bankruptcy Code).
An Example of “Impairing Your Homestead Exemption”
Here are the conditions that have to be met, applied to a hypothetical example.
- The judgment lien that is being gotten rid of must be attached to your “homestead.” That is legally defined differently in different states but generally means the place where you live. So assume you live in a home titled in your name, with a mortgage—that’s your homestead. In our example it’s worth $200,000 with a $180,000 mortgage, and so has equity of $20,000.
- The equity in your homestead must be protected by a “homestead exemption.” State and federal laws provide different amounts of protection for your home. It’s usually described as a certain maximum dollar amount of equity. In our example assume a homestead exemption of $30,000. Since that’s more than your $20,000 in equity, all of your equity is protected by the homestead exemption.
- The lien being removed must be a “judicial lien.” That’s defined in the Bankruptcy Code as “a lien obtained by judgment, levy, sequestration, or other legal or equitable process or proceeding.” And that judgment lien can’t be based on child or spousal support, or a mortgage foreclosure. In our example you’ve been sued by a collection company for an unpaid $15,000 medical bill. You knew you owed the money so you didn’t respond to the lawsuit. So a judgment was entered against you, which turned into a judgment lien against your home. This is the kind of “judicial lien” that could potentially be removed in bankruptcy.
- That judgment lien must “impair the homestead exemption” to be able to get rid of it through bankruptcy. This generally means that the judgment lien attaches to equity that is protected by the applicable homestead exemption. In our example the $15,000 judgment lien attaches to the $20,000 in equity in the home. ALL of that $15,000 of equity is included in the equity that is protected by the homestead exemption. So, the ENTIRE $15,000 judgment lien would be removed by filing bankruptcy. The underlying medical debt would be written off. You would owe nothing and the judgment lien would be gone.