One of the great benefits of a Chapter 13 case (
and, as discussed below, Chapter 7 cases in some states) is the ability to “strip,” or remove, a second or junior lien from your house if the value of the house is less than the outstanding balance of the first, or senior, lien. For example, If your house is worth $200,000 and you have a first priority loan with a balance of $205,000 and a second priority line of credit with a balance of $23,000, you can ask the Court to strip the second lien from the house. Why is this important? Because, assuming you complete your Chapter 13 Plan, that lien is gone forever. In addition, because you will have converted the secured debt into unsecured debt, which you paid in your Chapter 13 Plan, you will get a discharge of the remaining debt from that second priority loan. You will emerge from your Chapter 13 case with no lien and no debt for that line of credit, and can focus on paying off only the first mortgage. Importantly, the availability of lien stripping is a bright line test. If the house in the example is worth $206,000, the second lien cannot be stripped.
Let’s look at the same example as if lien stripping were not available, or the house is worth just a little more so that the second lien cannot be stripped. When you emerge from the Chapter 13 case, you still owe approximately $228,000 (or maybe a little less for principal paid during the Plan) for a house that is only worth $200,000, assuming the value remains constant. That means you will never own the house until you pay off both loans and you will not be able to sell it without lender approval until it reaches a point at which the house is worth more than the balances of both loans. If you cannot make the payments on both loans, you may face foreclosure. In the last few years, lien stripping in Chapter 13 cases has been a great benefit to many people because of the dramatic drop in property values. Even people who originally had equity above all loan balances found themselves in a position of owning a house that was not even worth the balance of the first loan. Of course, this analysis presumes you want to keep the house. You can always choose to give up a house, and get a discharge of all the debt, if you decide to do so (and the availability of lien stripping may be relevant to that decision).
In order to strip the junior lien, a motion is filed with the Bankruptcy Court, with notice to the lenders, requesting that the junior liens be stripped and setting out the basis for the request. In many cases, the lender will not even contest the motion unless they believe the debtor’s valuation of the house is wrong. How do you come up with the value for the motion? While judges in different districts may have different rules, in the Northern District of Georgia judges generally require at least an opinion from a real estate agent or broker. If the lender contests the motion, you will need to get an appraisal because the lender will probably have their own. While Zillow and other online resources are often good for a rough estimate, they should not be relied upon as evidence for the motion. The same applies to county tax assessments. An appraisal is a small price to pay for stripping a lien. In a contested case, the Judge will hold a hearing and each side will present their appraisals and the appraisers will testify. The appraisers will have the opportunity to justify their value and critique the other side’s appraisal. Ultimately, the judge will decide which value is correct, or perhaps come up with his or her own value somewhere in the middle. Generally, the burden is on the debtor to prove that they are entitled to strip the lien.
Finally, if you read about lien stripping on the internet, you will probably read that it is limited to Chapter 13 cases. That is still true in most states, and was true in all states until recently. However, in 2012, the 11th Circuit Court of appeals held that unsecured liens can also be stripped in Chapter 7 cases. The case is McNeal v. GMAC Mortgage, LLC and you can read more about the case in this post in the Georgia Bankruptcy Blog. While the issue is probably going to be decided by the Supreme Court or Congress in the near future, for now people in Georgia, Florida and Alabama can take advantage of the benefits of lien stripping even if the law is changed later. Update – Lien stripping in Chapter 7 cases no longer allowed after Supreme Court ruling.
Lien stripping is a powerful tool in Chapter 13 cases (
and some Chapter 7 cases). If you are facing financial problems and believe you may be able to get rid of second or third priority liens on your house, make an appointment with a Bankruptcy lawyer or two to review your situation. While there is usually no need to rush to the Courthouse to file a case and strip a lien, the reality is that property values are rising in many areas and it may not be available if your house increases in value so that it is worth more than the first mortgage. If you are in Georgia, call a local Bankruptcy lawyer or contact us and set up a meeting or a phone call.