Can I Eliminate My Second Mortgage in Bankruptcy

The current financial crisis, brought on by the collapse of the housing market has more and more people looking for solutions to their “under water” property. An “under water” property is one in which the debt on the property is greater than the value. Today, millions of homeowner are now upside-down or “under water” on their home mortgage and they are looking for a way out.

With drops in value as much as 40 – 50%,  the solution for many homeowners is to simply walk away  without ever exploring ways to save their home. There are, however, options. They include loan modifications of reduced interest and principal as well as the possibility of buying or cashing out, at great discounts, lenders who would rather have cash than take over an underwater property.

One solution that is not given enough attention, is the possibility of lien stripping a second trust deed through Chapter 13 bankruptcy. Today, if you own real estate with a second or third mortgage, chances are you can remove that lien in a Chapter 13 bankruptcy case. This is because with real estate declining as much as it has, many second mortgages may be considered unsecured and will be treated as such in Chapter 13.

In a Chapter 13 bankruptcy, which is plan of debt repayment over time, liens can be stripped off of the debtor’s assets when there is not enough equity in the asset, after deducting senior liens from current market value, to secure the  junior lien.  

Section 506 of the Bankruptcy Code provides that a lien is only secured to the extent there is value in the asset to which it attaches. If a claim exceeds the value of the collateral, that portion of the claim is considered unsecured.  As a result, in Chapter 11 or Chapter 13, even voluntary liens like mortgages and trust deeds can be stripped down to the value of the collateral.

There is a significant wrinkle, however, which greatly limits the ability of a debtor to strip off or wipe out his or her second mortgage or trust deed.  As presently enacted, the bankruptcy code prohibits the stripping of liens that are  “secured only by a security interest in real property that is the debtor’s principal residence” 11 U.S.C. 1322 (b) (2)The effect of this limitation, in many states, is to completely eliminate the possibility of a lien strip on residential real property that is the principal residence of the debtor.  By its very language, however, residential property that is held for investment and not as a “principal residence”  may be lien stripped.

Court decisions throughout the country have also uniformly held that when the debtor has given other collateral, in addition to the personal residence, as security for the mortgage, lien stripping will be allowed.  Thus, if the second trust deed is secured both by a debtor’s residence and other collateral owned by the debtor, be it another piece of real property or even something as simple as household goods, then lien stripping a second mortgage is permitted.

Finally, in many of the federal circuits, including the 9th Circuit which encompasses the state of California, bankruptcy courts have held that in those cases where the senior lien equals or exceeds the market value of the residence,  the second lien is unsecured and may be stripped. This is because, according to the judicial interpretation of these circuits, a completely unsecured lien does not fall within the specific limitations set forth in 11 U.S.C. 1322 (b) (2).

Because the real estate market in California is in such a state of distress, in many cases even the first trust deed has a face value in excess of the market value of the real property. In California  and in the other federal circuits which follow this rule, where the value of the property is less than the amount due on the first, a second or other junior lien may be stripped off even a personal residence.

So before you make the final decision to surrender your real property back to the bank, consider consulting with an experienced bankruptcy attorney and discuss with him the possibility of lien stripping your second and other junior mortgages.  You just might be able to keep that house of yours without that second mortgage.