Lien Stripping in Chapter 13 (Bankruptcy Basics)

What Does It Mean to “Strip” a Lien in a Chapter 13 Case?

Simply put, if you own a piece of real estate, and there’s more than one mortgage on that real estate, and the value of the property is less than the amount owed on the first mortgage, and you file a Chapter 13 bankruptcy case, the idea is that there is no equity present to secure the second mortgage.  Therefore, the second lien is “stripped,” and the second mortgage is treated like unsecured debt (like credit cards and medical bills).  The benefit of having that mortgage treated like unsecured debt is that it becomes subject to discharge and allowing you to pay less than 100% of the amount owed.  It’s important to note that the principle applies to all subsequent liens, e.g. HELOCs and HOA liens.

Lien Stripping in Chapter 13 in More Detail

Many homeowners have more than one mortgage on their homes. And depending on the vicissitudes of the residential real estate market, many homes are worth less than what the homeowners owe on them. That means that if a lender foreclosed on a house and sold the house at auction, there wouldn’t be enough money to pay off all of the lenders. Bankruptcy law has a process where homeowners who owe more on their home than it is worth can have a second mortgage striped away or wiped out by the order of a bankruptcy court.

Not all debts are considered equal in bankruptcy. Some debts are given a higher priority than other debts. In the case of real estate the earliest recorded lien is given the highest priority by the court. For most homeowners this means that a first mortgage will be a higher priority debt than a second or third mortgage. Because there are never enough assets to pay all creditors back in full, the court gives priority debts the first chance at getting paid back. Debts with lower priority are often completely erased, with the creditor not getting anything.

A mortgage is the most common type of lien that can be entered against real estate, but there are other types of liens such as from a court judgment or an HOA lien. Lien striping works for more than just mortgages, but may be limited in certain situations such as cases where a divorce judgment has created a lien.

The Difference Between Secured and Unsecured

Debt can either by secured or unsecured. Secured debt means the debt is attached to something particular. A mortgage is a secured debt because it is backed by the real estate. The creditor has the right to foreclose if they are not paid. But, when there are multiple mortgages on a home and the fair market value of the home is less than the amount owed on the mortgages, some of the mortgages are not secured by the house. The rule for these mortgages is that if the house were sold and there would not be enough money to pay off the first mortgage, all the other junior mortgages are wholly unsecured.

Lien stripping allows a court to erase the wholly unsecured mortgage.

Not All Bankruptcies Work the Same

If you are behind in your house payments or are facing foreclosure the only way to protect your house in most circumstances is to file for a Chapter 13 bankruptcy. A Chapter 13 bankruptcy allows the court to restructure your debts so that you can pay off the highest priority debts, such as a first mortgage, while lower priority unsecured debts are often erased.

Usually a Chapter 7 bankruptcy will not work to save a house because Chapter 7 is not about restructuring your debt and is instead about liquidating certain assets and paying off as many creditors as possible before erasing the rest of the debts.

However, every case is unique. If you are having difficulty staying current with your house payments, you need to get expert advice. You may be able to benefit from a bankruptcy that lets you keep your home and strips off other liens. Don’t wait to get good legal advice until its too late. Contact a bankruptcy lawyer today.

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