Second Mortgage “Stripping”
Avoidance of Second Mortgages Using Chapter 13 and Bankruptcy Code Section 506(a): Lien Stripping
One of the advantages of filing bankruptcy under Chapter 13 is that an entirely unsecured second mortgage, or other junior mortgage, can be avoided and removed from your homestead. This is done by using section 506(a) of the bankruptcy code to avoid the second mortgage, when it is not secured by any actual value in the homestead real estate. This mortgage is then treated by the Chapter 13 plan as an unsecured claim, the same as a credit card or other unsecured debt. Consequently, it only has to paid a small dividend, rather than being paid in full as for most home mortgages in bankruptcy.
“Stripping” unsecured second mortgages cannot be done in Chapter 7 cases. Also, it can only be done when your home’s market value is less than the entire balance owed on the first mortgage, rendering the second mortgage entirely unsecured by any value of the home. This means that in deciding whether to seek to avoid a second mortgage, a new appraisal of your home will be necessary.
Second mortgage lien avoidance is allowed by bankruptcy code sections 506(a) and 1322(b), and by Minnesota Local Bankruptcy Rule 3012-1. It requires committing to a three to five year Chapter 13 repayment plan, where the now-unsecured second mortgage is paid based upon your ability to repay it, the same as your other unsecured debts.
If you are wondering whether avoiding the second mortgage on your home can really be done (I know, it sounds too good to be true), consider that second mortgage lien avoidance for home mortgages has long been the law in every other appeals court circuit of the United States. In the Eighth Circuit, however (Minnesota is part of the federal Eighth Circuit), there was no appeals court authority for second mortgage lien avoidance until August 2011.
And you needn’t take just my word for it -- both the Minneapolis Star Tribune and the Minnesota Lawyer published news stories on this new-to-Minnesota legal development after the case allowing it was decided. Other Minnesota bankruptcy lawyers are now also using Chapter 13 to avoid second mortgages. It’s fair to say this is the most important legal development in Minnesota mortgage/bankruptcy law in years.
So yes, homestead second mortgage lien avoidance is real. My office has successfully obtained the confirmation of dozens of chapter 13 plans stripping second mortgages, where the fair market value of the home has dropped by enough to render the second mortgage unsecured by any actual value in the home. A “stripped” second mortgage is the result, which never has to be repaid. The result is a federal court order, recorded in the county recorder’s office, establishing that the second mortgage is no longer a claim against the home.
In some cases, getting rid of an expensive second mortgage payment could be the godsend that allows a homeowner to keep his or her home. Call my office to find out whether your second mortgage could be stripped off in a chapter 13 case.