Many people have multiple liens on their properties. During some economic downturns, the value of houses goes 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.
Lien stripping is not available in Chapter 7.
You cannot use lien stripping in Chapter 7 bankruptcy. In 2012, the 11th Circuit Court of Appeals ruled that lien stripping was available in Chapter 7. This temporarily allowed Chapter 7 filers in some Southeastern states to use this method. However, the Supreme Court explicitly reversed the 11th Circuit in 2015, restricting lien stripping throughout the US to Chapter 13.
How Does Lien Stripping Work?
You are only permitted to strip a junior lien if the amount of the senior lien or liens is greater than the fair market value of the home. Suppose, for example, that your house is worth $325,000, and you have a first mortgage worth $250,000, a second mortgage worth $100,000, and a third mortgage worth $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.
A filer who does not complete their Chapter 13 repayment plan will remain responsible for any liens that were 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.