September 24, 2017

Chapter 13–Lien Stripping: Hope for Homeowners

Rick MitchellAfter several years of speaking with our clients about loan modifications to save homes and hearing a sad litany of misinformation and outright deceptions, it has become painfully obvious that loan modifications are more smoke and mirrors than reality.

Does this mean that there is nothing that homeowners can do to try to save their homes?  Unfortunately, in most instances the answer is yes.

However, there is a way that some homeowners can protect their homes by the use of something called lien stripping.

Lien stripping: great option for the few who can qualify

Unfortunately, lien stripping works only in a narrow set of circumstances.  There are three elements that must be present.

  • First, there must be a first and second mortgage on the home.  A home equity line of credit (“HELOC”) is one form of second mortgage.
  • Second, the value of the home must be such that there is no equity to secure the second mortgage.
  • Third, if the homeowner did not have to pay the second mortgage payment, he or she would be able to afford the home.

If these three elements are present the homeowner may file a Chapter 13 bankruptcy reorganization and propose a plan that strips the second mortgage.  Stripping means that the second mortgage is removed as a mortgage lien on the home, and the second mortgage lien debt becomes a general unsecured debt that can be paid pennies on the dollar.

John and Jane Doe strip their lien

An example of lien stripping involves John and Jane Doe.  The Does have a home with a value of $175,000.  They have a first mortgage lien to Number One Lender Bank of $180,000 with a payment of $1,500 per month.  They have a second mortgage lien of $50,000 to HELOC Bank with a payment of $350 per month that is an interest only payment.  The Does can afford the first mortgage payment, but they cannot afford both the first mortgage and second mortgage payments.  In addition, they realize that the property is worth far less than what is owed on it, and since the loan with HELOC Bank is interest only, they are making little if any progress toward creating any equity in the home.

In this situation, the Does can file a Chapter 13 reorganization case and propose to strip HELOC Bank’s second mortgage lien.  The debt owed to HELOC Bank is treated in the plan as a general unsecured creditor along with other general unsecured creditors such as credit cards, medical bills and the like.

The general unsecured creditors are paid based on the financial ability of the Does to make payments and in many instances these payments can be five percent or less of the debt, with no interest, over a period of up to five years.  At the end of the plan, the bankruptcy court will enter an order stating that the HELOC Bank’s second mortgage lien no longer encumbers the Does’ home.

Who cannot use lien stripping

Simply having a second mortgage will not help a number of homeowners.  In order to have the ability to strip a second or third mortgage lien, there must be not one penny of equity securing the second mortgage lien.

In the example above, if we assume that the value of the property is $185,000 with all the other factors remaining the constant, there will be $5,000 in equity securing HELOC Bank, thus the Does cannot strip the lien.

Do not hesitate to attempt lien stripping

Consultation with a qualified bankruptcy attorney is essential for those thinking about lien stripping. If the attorney believes that the property is low enough to allow for lien stripping, it makes sense to proceed since creditors do not have incentive to fight the proceeding. After all, if the creditor prevails, and the debtor afford the payments to keep the home, the creditor can’t get paid anyway. In a closed case the call will go to the debtor.

The problem we usually see is when there is sufficient equity in the home to prevent lien stripping while at the same time, the homeowner cannot pay the first mortgage. This is truly cause for a bankruptcy consultation.