How Can A Second Mortgage Be Eliminated?
November 4, 2022
Through Chapter 13 2nd mortgages can often be eliminated and reduced to an unsecured claim.
There are two sections of the Bankruptcy Code that in essence say a junior mortgage is a secured claim only if after deducting all senior liens there is still some equity left for the junior mortgage. If the property has no value beyond the first mortgage, the junior mortgage is no longer recognized in bankruptcy as being a lien.
When can this happen? Experienced lawyers frequently do this when the pay-off balance of the first mortgage exceeds the market value of the property.
An example: the property has a market value of about $125,000 while the balance of the 1st mortgage is $137,000. There is a 2nd mortgage with a balance of over $20,000. The 2nd mortgage can be avoided in its entirety and paid as a general unsecured debt with, hopefully, a very low dividend.
If there is even $1 of equity for the 2nd mortgages the lien cannot be avoided. So if the value of home is $140,000 while balance of the first mortgage is $137,000 the lien cannot be avoided (with one possible exception discussed below.)
If there is not one penny of equity in the property the 2nd mortgage can be avoided and its claim treated as a general unsecured claim. Most unsecured claims are paid with a very small dividend percentage determined by an individual’s income.
RECORDING THE RELEASE OF THE MORTGAGE
The wording of the Bankruptcy Code provided that the Release of the mortgage can only be recorded upon completion and discharge of the Chapter 13 case. That means that if the Chapter 13 is dismissed or converted to a Chapter 7 you cannot record a release of the 2nd mortgage.
PARTIAL EQUITY OF A JUNIOR MORTGAGE
There is one exception to avoiding a 2nd mortgage where there is some small equity. If under the terms of the mortgage the final payment is due within the term of the Chapter 13.
Example: The mortgage on its own terms is due to expire in 4 years and its current balance is $12,000. After deducting all senior liens there is equity of $3,000. A Chapter 13 can be constructed for a term beyond the 4 years to pay the $3,000 in full and the balance of $9,000 to be paid as a general unsecured claim with, hopefully, a small dividend. The term of the Chapter 13 must go beyond the 4 year term of the mortgage.
If you file a Chapter 7 you can get a discharge of your personal liability on the 2nd mortgage debt but the lien remains on the property. If you want to save your home and get rid of the 2nd mortgage this is not the way to go.
There is no Chapter 20 in the Bankruptcy Code. The term “Chapter 20” is short hand for a Chapter 13 filed shortly after a discharge in a Chapter 7.
When a Chapter 13 is filed within 4 years of a prior Chapter 7 the Debtor cannot receive a Discharge.
Can you avoid a 2nd mortgage in a “Chapter 20” case?
The majority view is that you cannot as you cannot receive a discharge.
There is, however, a minority (and I believe better) view that you can. The reasoning is that the 2nd mortgage debt was discharged in the prior Chapter 7. Therefore, in the new Chapter 13 the 2nd mortgage is not a secured claim.
Christine Adams of our firm successfully litigated this issue in a Lake County case called Anderson v. Harris Bank. Christine persuaded the judge to rule that a debtor may strip a wholly unsecured lien in a Chapter 13 where no discharge is available. The unpublished decision was entered by A. Benjamin Goldgar in the United States Bankruptcy Court in the Northern District of Illinois.
In this day in age many homeowners are saddled with “underwater” 2nd mortgages. For a more in depth analysis about saving your home and getting rid of a 2nd mortgage call us. Our consultations are confidential.
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