Bankruptcy

What is "Lien Stripping" and Can I Use it to Reduce my Mortgage Payments

By Jonathan

With the decline in Atlanta area housing values, a seldom used bankruptcy technique has taken on new life.  The technique is called "lien stripping" and it arises from Bankruptcy Code Section 506(a) and (d).  A lien strip allows a Chapter 13 debtor to use the power of the Bankruptcy Court to transform a secured second mortgage or home equity line of credit into an unsecured debt, thereby eliminating a monthly payment and reducing total debt by tens of thousands of dollars.

Here's how it works: Let's say that you own a home worth $250,000.   Perhaps that home was worth $350,000 three or four years ago but its market value has dropped because of the recession.  The balance on the first mortgage is $270,000 and the balance on the second mortgage is $45,000.

In this case, a Chapter 13 debtor can ask his bankruptcy judge to "strip away" the second mortgage debt since all of the value in your home is encumbered by your first mortgage.  In other words, if you were to sell your house, the first mortgage lender would not be paid in full and the second mortgage lender would get nothing.  The second mortgage lender is, therefore, unsecured.

Lien stripping only works when:

• you are a debtor in a Chapter 13 case
• the fair market value of your house is less than the balance due on your first mortgage

The Clerk's Office of the Northern District of Georgia has provided us with sample lien stripping motions, which you can review by clicking on the link.

I suspect that mortgage companies will mount challenges to lien stripping.  There has already been a Minnesota case where a local judge there refused to allow lien stripping.   One day this issue may be considered by the United States Supreme Court.  For now, however, most bankruptcy judges will allow lien stripping and if your second mortgage or HELOC is fully unsecured, you may want to consider it as well.

My friend and colleague, Charleston bankruptcy lawyer Russ DeMott has published a clear explanation of how he approaches the mortgage lien stripping process (in his district, they refer to lien stripping as "mortgage stripping" but the concept is identical.  You can read Russ' post by clicking on the link.  Russ correctly points out that out of banks and mortgage companies have not cooperated in out of court mortgage modifications and that lien stripping remains perhaps the most reliable tool to modify a mortgage.

I have successfully "stripped" several junior mortgages.  Not surprisingly, the main issue that arises has to do with the fair market value of the home.  You may need to pay for an appraisal to convince the judge that the second mortgage is, in fact, fully unsecured.

Full post as published by The BK Blawg on December 20, 2010 (boomark / email).