Lien Stripping in Bankruptcy
Many people have multiple liens on their properties. Since the economic downturn, however, the value of houses has gone down dramatically, leaving many junior mortgages (the subsequent mortgages) unsecured. The priority of a lien against other liens is based on when the lien was recorded, with the earliest recorded lien or first mortgage holder taking priority over the subsequent liens.
Lien stripping is the process of eliminating junior liens during Chapter 13 bankruptcy. It allows a bankruptcy filer who is “upside down” on his or her house to wipe out liens on a parcel of real property that are wholly unsecured. You are upside down on your house if your mortgage is greater than the fair market value of your home.
In almost all states, you can only use lien stripping by filing a Chapter 13 bankruptcy. Because of a 2012 11th Circuit Court of Appeals case, however, it appears that Georgia, Florida, and Alabama do currently allow you to remove junior liens in Chapter 7 bankruptcy. This area of law may change, so if you are a homeowner in one of those states, you should consult a bankruptcy attorney about this issue before filing for bankruptcy.
How Does Lien Stripping Work?
You are only permitted to strip a junior lien if the amount of the senior loan is greater than the fair market value of the home. Suppose, for example, that your house is worth $350,000, and you have a first mortgage of $250,000, a second mortgage worth $100,000, and a third mortgage of $50,000. In that case, since the first and second mortgages fully secure the value of the house, leaving the third mortgage unsecured, the court can strip the third mortgage. However, you will still be responsible for the other two mortgages.
In contrast, if your house were worth $375,000 and you had three mortgages of the same amounts as the above example, the third mortgage would be partially secured by the house. The third mortgage in that case could not be stripped. In some cases, the mortgage holder may challenge your appraisal of the fair market value of the home if you claim that the junior mortgage is wholly unsecured. In that case, the court may hold an evidentiary hearing, during which your appraiser will be required to testify, to determine if the fair market value is less than or more than what is owed on the mortgage or mortgages that are not to be stripped.
When you ask the bankruptcy court to “strip” a lien, you are asking the court to convert junior mortgages that are not fully secured into unsecured debt. This means that the converted junior mortgage will be removed from the property and treated like any other non-priority debt that is not secured by collateral, such as medical debt or credit card debt. You will have to pay a part of this unsecured debt through your Chapter 13 plan, but usually you only have to pay a small amount.
Once you complete the plan, your unsecured debt, including the stripped junior mortgage, is discharged. If you do not complete the plan, however, the junior mortgage will not be stripped, and you will still be responsible for paying it.