Eliminating 2nd Mortgages Also Called Stripping or Cramming Down
November 3, 2022
WOULDN’T IT BE NICE TO GET RID OF A 2ND MORTGAGE AND SAVE THOUSANDS OF DOLLARS?
Homeowners and other property owners often discover that their property’s market value is less than the balance of the first mortgage. On top of that many have second mortgages and/or Home Equity Loans.
How do you keep the property and get rid of the 2nd mortgage: the answer may be a Chapter 13.
The ability to avoid a 2nd mortgage or other junior lien comes when the market value of the property is less than the senior liens including a 1st mortgage plus accrued and owed real estate tax liens. The same analysis would apply if there were a 3rd mortgage or IRS lien.
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.
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.
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.
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. Other judges are following this reasoning but as yet it is not universal.
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 Complimentary and confidential.