Did you know that Americans owe more in mortgage debt than any other type of debt? Last year, total U.S. mortgage debt reached a new record of nearly $9.5 trillion.
Becoming a homeowner is undoubtedly a part of the American dream, but millions of people struggle to accomplish this goal or maintain their homeownership amidst the instability of the housing market—especially today, with the rippling economic effects of the COVID-19 pandemic.
According to the Federal Deposit Insurance Corporation, approximately 1 million new families experience foreclosure each year. Foreclosure is the legal process in which a mortgage lender seizes and sells a borrower’s home when they fall behind on payments.
If you are facing foreclosure (or believe it may be on the horizon) you may be considering bankruptcy, but you might not be sure whether it will help. Bankruptcy only discharges unsecured debt like medical bills and credit card debt. Because mortgage debt is secured, it is not eligible for a regular debt discharge.
However, bankruptcy is often quite helpful for homeowners because it initiates the automatic stay. This court order prevents creditors—including mortgage lenders—from collecting your debt in any way. When you file bankruptcy, therefore, the automatic stay will likely prevent your lender from initiating (or continuing) the foreclosure process.
This is, of course, a temporary fix. The automatic stay only lasts for the duration of your case. If you aren’t caught up on payments by the end of your bankruptcy, your lender can still foreclose your home and evict you and your family. This is why many homeowners choose Chapter 13 bankruptcy if they’re worried about losing their homes, as Chapter 13 gives you 3-5 years to make monthly payments and catch up on arrears for secured debt.
But additional time to catch up on delinquent payments isn’t the only way bankruptcy can improve your situation. You may be able to actually reduce your monthly payments through a lien-stripping process.
Stripping a Lien Through Chapter 13
Before we discover what it means to strip a lien, let’s first discuss what a lien actually is.
A lien is a legal claim to a property. If someone attaches a lien to your property, they have the right to seize it unless you pay what you owe them. A lien may become attached to your property if one of your creditors sues you and obtains a judgment against you, and the judgment allows them to place a lien on one of your assets.
Other times, liens are voluntary, meaning you agree to the lien when you purchase a property. For example, a mortgage lender or automobile lender places a lien on your home or vehicle when you buy it. This is why mortgages and car loans are called secured debt—they are secured by the collateral of your home or vehicle, and the lien gives the lender the right to take that property if you don’t make your payments.
Lien-stripping, therefore, is when Chapter 13 bankruptcy removes the lender’s right to take your home when you don’t make your mortgage payments. Some refer to this process as converting the mortgage debt from secured to unsecured, as the debt is no longer secured by the lender’s right to seize the collateral. Once you finish your Chapter 13 repayment plan (a 3-5-year process), the court can discharge that mortgage along with other unsecured debt.
The catch, however, is that a bankruptcy court can only strip a lien attached through a second and/or third mortgage. Otherwise known as a home equity loan, a second or third mortgage is an additional loan you take out to cover other expenses. The loan is secured by the equity you have in your home. For example, if you have $50,000 in equity, you can take out a second mortgage of up to $50,000. Your second mortgage lender has the right to the equity until you pay off the loan.
Another catch is that you must be upside down on your first mortgage (the mortgage you took out to buy your home) in order to qualify for this process.
For instance, let’s say:
- Your home is worth $175,000;
- You owe $200,000 on your first mortgage; and
- You took out a second mortgage of $30,000.
Because your home is worth less than what you owe on your first mortgage, the bankruptcy court can order your second mortgage lender to remove the lien on your home, and the $30,000 can be discharged at the end of your case. If you have a second AND a third mortgage, you may be able to complete this process for both mortgages if what you owe on your first and second mortgage combined is greater than the value of your home.
Unfortunately, bankruptcy cannot modify the first mortgage on your primary residence, even if you owe more than what its worth. Reducing a loan to the value of the property is called a cramdown, and it’s actually fairly common with automobile loans.
Let’s Explore All Your Options
At Dethlefs Pykosh & Murphy, we help clients take advantage of debt-relief options they never knew existed. Bankruptcy offers a wide range of benefits, and we can help you determine which chapter may help you overcome your financial hardship in as little time as possible. Whether you’re hoping to eliminate as much debt as possible, rescue your home from foreclosure, or accomplish any other debt-related goal, we can provide the skills and experience you need to succeed.