Generally, the Bankruptcy Code prevents any modifications to the mortgage when filing for bankruptcy. However, individuals who file for protection under Chapter 13 of the Bankruptcy Code, rather than Chapter 7, have the luxury to completely remove the second or third mortgage. Numerous federal courts have held that when the amount of the first mortgage is more than the value of the property, the second and third mortgages are no longer secured and can be completely removed. There’s one caveat to this – the strip-off of a wholly unsecured mortgage is effective only upon fulfillment of the Chapter 13 payment plan over an average period of three to five years. In other words, if your bankruptcy case gets dismissed by the court for any reason or gets converted to a Chapter 7, any junior mortgage that you sought to discharge will survive.
Below is a made-up scenario to help illustrate the mortgage stripping process:
Alice owns a home that she purchased back in 2010 for $250,000.00. After making payments for five years, Alice took out a Home Equity Mortgage in the amount of $20,000.00 to remodel her kitchen. A year later, Alice lost her job, was forced to live off her credit cards, and currently cannot afford to pay for all of her expenses. Because of all of this, Alice decides to file for bankruptcy. At the time Alice files for bankruptcy, her home is valued at $220,000.00, but she owes more than $225,000.00 to the bank that gave her the first mortgage. Alice also owes $18,000.00 to the lender that gave her the Home Equity Mortgage. Since the value of Alice’s home is less than what she owes to the primary lender, the second mortgage is considered wholly unsecured. Since Alice’s home is technically “underwater,” she may remove the Home Equity Mortgage completely. In other words, Alice will no longer be legally obligated to pay for her second mortgage.
This is the typical scenario that we see at Kalikhman & Rayz, LLC. However, bankruptcy cases are very fact specific and require careful analysis before filing. If you think that you may benefit from a Chapter 13 filing, please don’t hesitate to contact our office. Consultations are always free.