Remove a Second Mortgage from Your Home in A Chapter 13 Bankruptcy

Homeowners whose homes are over-burdened with mortgage debt beceause of the real estate bubble have recently been given a powerful tool to help them stay in their homes. In Fisette v. Keller the 8th Circuit Bankruptcy Appellate Panel ruled that people who file for Chapter 13 protection can remove a wholly unsecured second mortgage on their home in bankruptcy. This can be a powerful tool for homeowners with second mortgages whose homes are underwater. Many bankruptcy jurisdictions around the country have allowed debtors to remove wholly unsecured second mortgages from their homesteads since the U.S. Supreme Court decision of Nobleman v. American Savings Bank (1993). In Nobleman, the USSC examined the relationship between two provisions of the bankruptcy code: §§ 506(a) & 1322(b)(2). Section 1322(b)(2) permits a Chapter 13 debtor to “modify the rights of holders of secured claims, other than a claim secured only by a security interest in real property that is the debtor’s principal residence . . .” Section 506(a) states that a secured claim is secured to the extent of the creditor’s interest in the value of the subject property and is unsecured to the extent that the value of the creditor’s interest is less than the amount of the secured claim.

The idea behind § 506(a) is that when a creditor who has a lien in a piece of property for the amount of the debt, and the property is worth less than the amount of the debt, the lien (aka the “secured claim”) is secured up to the value of the property and unsecured as to the balance. For example, if you purchased a vehicle worth $20,000 with a $20,000 loan and granted the creditor a lien in the vehicle, the secured claim would be $20,000. Over time, as the vehicle depreciates more rapidly than the principal of the debt is reduced, the value of the secured claim becomes less than the value of the collateral. If the owner of the vehicle were to file for bankruptcy protection, the court pursuant to § 506(a) would conceive of the lien as secured up to the value of the vehicle and unsecured for the difference between the value of the vehicle and the remaining amount of the loan. If the vehicle were worth $13,000 on the date of the bankruptcy filing and $16,000 was owed on the debt, the creditor’s claim would be secured up to $13,000 and unsecured for $3,000. Under § 1322(b)(2), the person filing for bankruptcy could strip down the lien from $16,000 to $13,000 and treat the balance as general unsecured debt that may receive only a partial payoff.

Section 1322(b)(2) allows people filing for Chapter 13 bankruptcy protection to modify the claims of secured creditors through their Chapter 13 repayment plans, except for liens that are secured by the debtor’s home. Modifying the secured creditor’s rights in such a way is called “lien stripping” or a “strip down.” In Nobleman, the debtors were attempting to have the court allow them to reduce the principal of their mortgage from its current amount to the value of the home. The Court explained that the debtors could not modify the payment and interest terms for the unsecured portion of the claim without modifying the rights of the creditor with respect to the secured portion of the claim, thus violating § 1322(b)(2). The Nobleman decision held that § 1322(b)(2) bars Chapter 13 debtors from stripping down a creditor’s claim when any portion of that claim is secured by the debtor’s home. However, the Nobleman court did not directly answer the question of whether a debtor could strip off a wholly unsecured lien on the debtor’s principal residence. Essentially, the Nobleman decision is read to mean that the provision of 1322(b)(2) excepting lien stripping from a homestead mortgage doesn’t apply if the homestead mortgage is classified as unsecured under 506(a): for this to occurr, the mortgage must be wholly unsecured. This opened the door to allowing Chatper 13 debtor’s to strip off wholly unsecured second mortgages from their homes. Some jurisdicitions around the country allowed debtors to walk through that door. Minnesota bankruptcy judges, however, did not allow Chapter 13 debtors to strip off wholly unsecured mortgages. That has all changed with the Fisette opinion and the 8th circuit bankruptcy appellate panel has given a very powerful tool to homewowners struglling to make their mortgage payments on their home which is worth less than what they owe on it .

If you have a home that is currently worth less than what you owe on the first mortgage, and there is a substantial second mortgage on the home, you can file a Chapter 13 bankruptcy and remove the second mortgage completely from the home through the plan. Not to mention resolving your credit cards, medical debts and back taxes. For example, if your home is currently worh $180,000 and you have a first mortgage at $200,000 and a second at $50,000, you can strip the second mortgage off through a Chapter 13 plan and need only pay the first after your case is filed. This will allow you to reduce the gap between the value of your home and the debt owed against it. If you would like more information on how a Chapter 13 plan works, click here. You can even use a Chapter 13 to stop the foreclosure on your home and bring the back mortgage payments current through the Chapter 13 plan. But you must contact us before the date of your foreclosure sale.

The Fisette decision even allows debtors who have filed a recent Chapter 7 to now file a Chapter 13 and strip the wholly unsecured mortgage off of their home. It appears that judges are open to allowing people struggling because of the real estate bubble to use the bankruptcy laws to protect themselves and their families. Call us now to learn more. We always offer free consultations with no obligation.