Bankruptcy for Homeowners: Credit Impact vs. Discharge of Mortgage Debt

While bankruptcy can have a detrimental effect on your credit, some homeowners can benefit greatly by "stripping" and discharging debt from second (even third) mortgages in a chapter 13 case.

Even in these difficult financial times, many who could really benefit from bankruptcy summarily dismiss it as an option. Good credit scores are a precious commodity these days, and no one wants the blot of a bankruptcy to stain their credit report. However, anyone who would benefit from bankruptcy probably already has issues with their credit history, or will soon. Even if you don't have a blot but are struggling to make ends meet, bankruptcy may still be a viable option before the ends actually stop meeting.

An Option for Homeowners With No Equity

For working homeowners who have no equity in their home and may not be making nearly as much money as before, there may be one compelling thing about bankruptcy that could save your home, save you money, and save you from stress: Stripping. No, not that kind of stripping... lien stripping.

Lien Stripping

Lien stripping simply means to remove the security interest that a junior lien holder (second mortgage) has on your home and to discharge (get rid of) that debt. This may be available in chapter 13 bankruptcy if you have an under secured first mortgage (your house is worth less than the first mortgage) and a second mortgage on your primary residence.

Here’s an example of how it works: Let's say that the market value of your home is $150,000; your first mortgage is $200,000; and your second is $50,000. If your home were sold, the first mortgagee would get the entire $150,000 with a $50,000 deficiency. Since there is no money left over, the second mortgagee would get nothing. The loan with your first mortgagee would be defined as partially or under secured. The loan with your second mortgagee would be defined as wholly unsecured. Here comes the good part: Wholly unsecured loans can be discharged (eliminated) in Chapter 13 bankruptcy. This means that you could keep your home and eliminate that $50,000 debt.

Impact on Your Credit vs. Benefit of Debt Discharge

So, even if you incur a blot on your credit, at least you’ll have your home, some peace of mind, and thousands of dollars of debt off of your shoulders, which are actually three good reasons to learn more about bankruptcy. Additionally, you will likely also be able to get rid of a portion (how much depends largely on your income) of other debts like credit cards, personal loans and medical bills.

The information herein is not legal advice to be used for any particular situation or circumstance. It is recommend that you consult a licensed attorney if you want a professional legal opinion that is appropriate for your particular situation.