Eliminating Junior Mortgages Through Bankruptcy

Lien stripping refers to the process of reducing a secured claim to the value of the underlying collateral. It uses the combined effect of Bankruptcy Code sections 506(a) and 506(d) to split the lien into secured and unsecured portions. The secured lien is allowed in the amount up to the fair market value of the property at the time of the stripping. The balance of the lien in excess of the fair market value of the property is treated as an unsecured debt.

California Attorney Helping Families Eliminate Junior Mortgages

At the Law Offices of Elliott Abrams, we strive to help clients deal with debt through a variety of ways, including eliminating a junior mortgage through bankruptcy. We also handle initial Chapter 7 and Chapter 13 matters, while encouraging other clients to seek credit counseling when appropriate. Our firm is focused on helping clients achieve their goals while also relieving stress and obtaining peace of mind. Contact attorney Elliott Abrams at our firm today to learn more about stripping a second mortgage.

In these tough economic times, many homeowners are living in properties whose values have dropped far below the outstanding mortgages. Generally vehicles that have been financed typically are worth less than the outstanding loan balance.

The most common application of lien stripping in Chapter 13 is the reduction of car loan liens to the present value of the vehicle and the elimination of junior (e.g., second) mortgages where the outstanding balance owing to the senior (e.g., first) mortgage exceeds the value of the property.

In a typical Chapter 13 plan, the secured portion of the vehicle loan is paid in full over the life of the plan and the unsecured portion is paid in the same manner as other unsecured debts such as credit cards.

There is one important limitation. Vehicle loans cannot be stripped to the fair market value of the vehicle under Chapter 13 where:

  • The loan was incurred within 910 days of the bankruptcy filing
  • The loan was used to buy the vehicle
  • The automobile was acquired for personal use

You should note that this limitation does not apply even for loans within 910 where the loan was not used to purchase the vehicle (e.g., where a previously owned vehicle was pledged as collateral for a loan) or where the vehicle was acquired for business use (e.g., a pickup truck acquired by a contractor).

Regarding mortgages on real property there is likewise one important limitation where the property is your residence. Bankruptcy Code section 1322 (b)(2)does not permit a bankruptcy plan to modify the rights of holders of a claim secured only by a security interest in real property that is the debtor's principal residence. That means that you cannot strip a mortgage that is partially secured. For example, assume that the residence is worth $300,000 and is encumbered by a first mortgage of $350,000 and a second mortgage of $150,000. Since the property is your residence, in a Chapter 13 (as well as in a Chapter 11) the Bankruptcy law does not allow you to strip the unsecured portion off of the first mortgage but it does allow you to strip the second mortgage from the property and treat it in the Chapter 13 plan as an unsecured debt.

Lien stripping is also available in the installment purchase of consumer goods more than one year prior to the bankruptcy filing where the merchant retained a secured interest in the goods.

Here is a Lien Stripping Example in the context of a Chapter 13 plan:

Assume:

  • Home is worth $300,000
  • The first mortgage is $350,000, is in arrears $25,000 with a $2000 monthly payment
  • A second mortgage for $150,000 payable interest only at $875 per month
  • Net monthly disposable income from the bankruptcy means test of $1000
  • A vehicle financed more than 910 days ago, which is worth $8000 with a loan balance of $12,000, a monthly payment of $550 and two years remaining
  • A TV financed more than one year ago, which is worth $1000 with a loan balance of $3,000
  • Outstanding taxes from last year of $10,000
  • Total credit card debt of $120,000
  • Attorney fees remaining to be paid of $3000

From the monthly plan payments of $1000, over the required 60-month length of the plan (in certain circumstances, the plan could be less than 60 months) you will have paid $60,000. After payment of the Chapter 13 trustee administration fee of $6000 (10 percent) and the balance of your attorney's unpaid fees of $3000, there would remain $51,000 for your creditors.

The arrearage of $25,000, the taxes of $10,000, and the secured portion of the vehicle loan of $8000 and of the TV of $1000 are paid next in full leaving $7000 to be paid pro rata to your unsecured creditors.

Assuming all the unsecured creditors file claims the total unsecured debt would be $122,000 (credit cards) plus $150,000 (second mortgage) plus $4000 (unsecured portion of the vehicle loan) plus $2000 (unsecured portion of TV loan) for a total of $276,000. The distribution to unsecured creditors would be 2½ cents on the dollar ($7000/$276,000). This is an approximation as the Trustee generally would pay interest on the arrearages and on the secured portions of the vehicle and TV loans (the taxes are not entitled to receive interest or penalty accruing after the date the bankruptcy is filed).

In addition to making your plan payments, you would only continue to pay the first mortgage and would pay nothing outside the plan to the taxes, the second mortgage, the vehicle loan, the TV loan or the credit cards.

At the completion of the plan you would own the house subject only to the first mortgage with the arrearages fully paid thru the plan. Your taxes and the secured portion of the vehicle and TV loans will also be fully paid and you will be entitled to the pink slip for the vehicle. You will be discharged from any further liability for the second mortgage, the vehicle or TV loans or any of the credit cards.

The potential benefits of a properly structured Chapter 13 can be tremendous. Now is the time to contact the Law Offices of Elliott Abrams for a consultation. There is no cost for an initial consultation regarding consumer bankruptcy, including what could be accomplished through a Chapter 13 plan.

We are a debt relief agency. We help people file for bankruptcy relief under the Bankruptcy Code.