A lien strip in Chapter 13 bankruptcy is one of the very few “silver linings” for the homeowner who has experienced the shock of seeing the equity in his or her home fall “underwater” due to the recession. It works on the concept that if the amount owed on a person’s first mortgage is greater than the fair market value of the home, then any second or “junior” mortgage has no equity to attach to and thus, under bankruptcy rules, is totally and completely unsecured. And since it is unsecured it is not entitled to protection of its lien under bankruptcy law and the lien may thus be eliminated by the bankruptcy discharge.
After the Chapter 13 is completed your house no longer has the junior lien on it and is on its way to regaining its equity and back on the path to again being a viable investment.
A lien strip will only work in a Chapter 13 Bankruptcy not a Chapter 7
The United States Supreme Court has ruled in Dewsnup v. Timm, 502 U.S. 410 (1992), that lien strips are not appropriate in Chapter 7. However, the Ninth Circuit Court of Appeals, applicable to us here in California, later approved lien strips for Chapter 13 in the case of Zimmer v. PSB Lending Corp., 313 F.3d 1220 (9th Cir. 2002).
Lien Strip Requirements:
- You qualify for Chapter 13;
- the fair market value of your house is less that the present balance on your first mortgage lien; and
- you have a second (or junior) mortgage lien on your house.
Here is an example of how a lien strip works:
Assume your house is worth $300,000 but you owe $325,000 on your first mortgage. Your house is thus $25,000 “underwater” when considering only the first mortgage. Assume further that you have a $100,000 equity line or HELOC loan also secured by a lien on your house. So, with two mortgage liens on your house you are now $125,000 underwater. Assuming you want to keep your house what can you do?
The answer is, if you can qualify for Chapter 13, under the above facts you can strip off the second lien and just continue making payments on the first. Your Chapter 13 plan will treat the second mortgage just like an unsecured credit card, so, for example, if your plan calls for paying a 10% repayment to unsecured debts you will also pay only 10% to the second mortgage over the course of the plan, which is usually 36 to 60 months.
At the successful conclusion of your Chapter 13 payment plan you will received a Chapter 13 discharge and the right to remove the second lien from your house. In our hypothetical example, your Chapter 13 lien strip just put you $100,000 closer to positive equity in your home.
Contact my office for a free office consultation to learn if you can qualify for Chapter 13 and a lien strip. It just may help you save your house.