In most bankruptcy districts, you cannot get rid of junior liens and mortgages (such as second and third mortgages, HELOCs, and home equity loans) from your home in Chapter 7 bankruptcy. But due to a recent 11th Circuit Court of Appeals case, you might be able to remove such liens and mortgages in Chapter 7 if you live in Alabama, Florida, or Georgia. This is called lien stripping.
(Learn more about what happens to your home and mortgage in Chapter 7 bankruptcy.)
In most bankruptcy jurisdictions, lien stripping is available in Chapter 13 bankruptcy only. If you have a second mortgage or junior lien on your home that is no longer secured by the equity in your home, you can strip it off (remove it). The stripped off lien becomes unsecured debt.
Example. Say your home is worth $400,000, your first mortgage balance is $410,000, and you have a home equity loan in the amount of $35,000. In this situation, your home equity ($400,000) is not enough to cover your first mortgage. This means there is no equity to cover any of your home equity loan. In Chapter 13 bankruptcy, you could strip off the home equity loan of $35,000. It would become unsecured debt, which you’d pay off in part (usually in pennies on the dollar) through your Chapter 13 plan.
For details on how lien stripping works, and for more examples, see the articles in Your Home in Chapter 13 Bankruptcy.
In most areas of the country, you cannot remove second mortgages or other junior liens from your home in Chapter 7 bankruptcy. However, in May of 2012, the 11th Circuit Court of Appeal ruled that Chapter 7 filers can use lien stripping in Chapter 7 bankruptcy as long as the entire lien or mortgage is unsecured. In Re McNeal, Case No. 11-11352 (11th Cir., May 11, 2012).
This means that if you live in one of the states within the 11th Circuit (Alabama, Florida, and Georgia), you may be able to get rid of junior liens in Chapter 7 bankruptcy. If a lien is stripped off, it becomes unsecured debt and will be discharged at the end of your Chapter 7 bankruptcy.
It’s almost certain that the 11th Circuit decision will be appealed to the U.S. Supreme Court. If you are filing for Chapter 7 bankruptcy and have junior liens on your home, check with a local bankruptcy attorney regarding the most recent status of the law. (Visit our lawyer directory to find a local bankruptcy attorney.)