If your primary residence has a first and second mortgage, or a first mortgage with a home equity line of credit, it may be possible to “strip off” the second mortgage and/or home equity loan from your home. In a declining real estate market, lien stripping may make it possible for you to avoid foreclosure and keep your home.
To understand how lien stripping works, it’s important to know a bit about the difference between secured and unsecured debt. A secured loan is backed by an asset—in the case of a mortgage loan, usually the property you’re borrowing to pay for. (Unsecured debt, by contrast, is not backed by collateral; the creditor simply loans you money and expects you to pay it back according to the terms of the loan agreement. Most credit card debt is unsecured debt.) Whereas unsecured creditors frequently do not receive the full amount of their claim in a bankruptcy case, the law usually entitles a secured creditor to receive full compensation up to at least the value of the collateral, or it may seize the collateral itself. For example, if you owe your lender $600,000 on your house and your house is worth at least that much, your bankruptcy plan must either provide for the lender to receive the full $600,000, or it must surrender your house to the lender. Usually, payment may be made over the original loan repayment schedule (which may be longer than the plan) so long as any arrearage is made up during the plan.
In a declining real estate market, however, lien stripping becomes a viable option for pursuing relief from some secured debt. For example, suppose the house in the previous example was purchased for $600,000 in late 2007, at the top of the market in Seattle. The debtor purchased the house with a $500,000 first deed of trust from one lender and a $100,000 second deed of trust from another lender. Since being purchased, the house has lost value and is now worth only $490,000. This is less than the value of the first deed of trust, so there’s no value left over to serve as collateral for the second deed of trust—it is considered “wholly undersecured.” In a Chapter 13 bankruptcy, you can move to have a wholly undersecured lien stripped from the property, meaning that it will be treated like an ordinary unsecured debt. If you and your attorney can develop a bankruptcy plan that provides for payment of the arrears on your first mortgage, eliminates your credit card debt, reduces your car payments, and entirely removes the second mortgage on your home, you may find that your whole financial picture looks very different, making it possible to keep your home.
Lien stripping is an example of debt avoidance, a legal term that basically means having a debt legally cancelled or reduced. A lien can also be stripped if it is a judgment lien that is undersecured and impeding a debtor’s homestead. Other common examles of avoidance on other property and houses other than the debtor’s primary residence include the ability to cram down the lien or mortgage to the value of the property, bifurcating the lien obligation into secured and unsecured elements.
Before making the decision to surrender your real estate to the bank, contact us and find out if we can help you stay in your home.