With the decline of housing values in Michigan generally and Metro Detroit specifically, a seldom used bankruptcy technique has taken on new life. The technique is called “lien stripping” and it derives from Bankruptcy Code Section 506(a) and (d). A lien strip allows a Chapter 13 filer to use the power of the Bankruptcy Court to transform a secured second mortgage or home equity line of credit into an unsecured debt, thereby eliminating a monthly payment and reducing total debt by tens of thousands of dollars.
Here’s an example: Let’s say that you own a home worth $250,000 with two mortgages. Perhaps that home was worth $350,000 three or four years ago but its market value has dropped because of the recession. The balance on the first mortgage is $270,000 and the balance on the second mortgage is $45,000.
In this case, a Chapter 13 debtor can ask his bankruptcy judge to “strip away” the second mortgage debt since the home is worth less than the first mortgage. In other words, if you were to sell your house, the first mortgage lender would not be paid in full and the second mortgage lender would get nothing. The second mortgage lender is, therefore, unsecured.
Lien stripping is only available when you are a debtor in a Chapter 13 case, and the fair market value of your house is less than the balance due on your first mortgage.
Mortgage companies can mount challenges to lien stripping. And one day this issue may be considered by the United States Supreme Court. For now, however, most Michigan bankruptcy judges will allow lien stripping and if your second mortgage or HELOC is fully unsecured.
I have successfully “stripped” numerous junior mortgages. Not surprisingly, the main issue that arises has to do with the fair market value of the home. You may need to pay for an appraisal to convince the judge that the second mortgage is, in fact, fully unsecured.