How to Strip a Second Mortgage or HELOC in Chapter 13
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One plus to filing for Chapter 13 bankruptcy is that you may be able to get rid of second or third mortgages on your home or get rid of home equity loans or home equity lines of credit (also known as HELOCs). Eliminating these loans is called lien stripping.
First Mortgages and Chapter 13 Bankruptcy
In Chapter 13 bankruptcy, you generally keep all of your property. However, if you have secured debts (loans for which you pledged property as collateral -- which means if you default on the loan the creditor takes the property), you must keep current on your payments. Otherwise, you'll lose the property. The Chapter 13 bankruptcy does give you an opportunity, however, to pay off arrerages through your repayment plan. (To learn more about Chapter 13 bankruptcy, see Chapter 13 Bankruptcy: An Overview.)
This means that if you wish to keep your home, you must continue to make your mortgage payments, and if you owe an arrearage, you must pay that back through your repayment plan.
Second and Third Mortgages and HELOCs in Chapter 13 Bankruptcy
Second and third mortgages, and home equity loans and HELOCs, on the other hand, may be treated differently in a Chapter 13 bankruptcy under certain circumstances. Specifically, if your home value has declined, and your equity no longer covers the first mortgage, then your other mortgages are no longer "secured." In this case, the bankruptcy court may "strip off" the second and third mortgages and recategorize them as unsecured debt.
In Chapter 13 bankruptcy, unsecured debt is given last priority and is paid through your repayment plan. However, unsecured debts are usually not paid in full in Chapter 13 bankruptcy and sometimes do not have to be paid back at all. Even if you do have to pay a portion of that debt back through your plan, when you are done with the three or five year plan, the remainder of the debt will be discharged.
How Lien Stripping Works
Here’s how lien stripping might work in a particular bankruptcy case.
Say your home is currently worth $500,000 and you owe $550,000 on the first mortgage. You have a second mortgage for $50,000. Because the first mortgage is larger than the value of your home, you have no equity in the home. That means the second mortgage is no longer secured by the value of your home. This case would be ripe for lien stripping.
Lien Stripping in Chapter 7 Bankruptcy
In most jurisdictions, lien stripping is only available in Chapter 13 bankruptcy. However, if you live in Alabama, Florida, or Georgia, you might be able to remove junior liens in Chapter 7 bankruptcy. To learn more, see our information on getting rid of second mortgages and liens in Chapter 7 bankruptcy.