Eliminate a Second Mortgage and HELOC in Chapter 13 Bankruptcy

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A Chapter 13 bankruptcy gives homeowners another option in their fight to stay in their homes and avoid foreclosure. This new option, known as lien stripping, results from the decline of real estate prices across the country. It presents an opportunity for homeowners which can cut monthly mortgage obligations and help to bring payments back in line with their current financial situation.

This opportunity, which is complex and best navigated by an experienced bankruptcy attorney, is targeted at second mortgages and/or home equity lines of credit. In situations where declining property prices have dropped the appraised value of your primary residence below the balance owed on the first mortgage, any subordinated loans behind the first mortgage are considered as “wholly unsecured.” This puts all subordinated mortgages and home equity lines of credit on par with credit card and other consumer debt.

Categorized as unsecured debt, your second mortgage and your home equity line of credit can be fully discharged in a Chapter 13 bankruptcy filing. Here’s an example of how it would work:

  • A couple bought their primary residence in Los Angeles County, Ca, for $895,000 at the end of 2005.
  • The purchase of the residence is executed with a first mortgage of $695,000 and a second mortgage for $200,000
  • After six months, they decide that the home needs some upgrades so they take out a home equity line of credit for $85,000
  • By early 2010, the value of the home has dropped to $650,000 and financial difficulties have them struggling to make ends meet.
  • Due to the drop in value of their residence, the second mortgage and the line of credit are no longer secured by the property at its current value.
  • The couple files for reorganization in a Chapter 13 filing. Working with their bankruptcy attorney, the homeowners have the wholly unsecured liens on their personal residence discharged due to their status as wholly unsecured.
  • The lien stripping of the unsecured loans results in the homeowners having a home valued at $650,000 with only a first mortgage of $695,000.

If the value of your primary residence has decreased, you could benefit by having your second mortgage and/or home equity line of credit dismissed in a Chapter 13 bankruptcy. A bankruptcy attorney can help to determine if your subordinated loans would be considered as wholly unsecured by the bankruptcy court. They can also determine whether you can benefit from the discharge of these obligations via lien stripping through a Chapter 13 bankruptcy.

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