By: Mohammed Badwan, Esq.
Although the 2005 amendments to the Bankruptcy Code through the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 (BAPCPA) made it more difficult for debtors to qualify for Chapter 7 relief; a provision providing substantial relief for debtors with underwater properties (mortgage on property exceeds property value) remained in intact. It is still possible for homeowners to strip off any wholly unsecure liens in a Chapter 13 bankruptcy. [1] A lien is unsecure when the property's value does not cover the value of the lien. This controversial provision resulted in legal warfare between debtors and banks. Banks relied on a bankruptcy provision that prohibits any modification of rights of holders of secured claims. [2] Debtors relied on a provision stating that lien holders are only secured to the extent of the value of the collateral; therefore, if a lien is wholly unsecure, it is void pursuant to the clear and unambiguous language of the statute. Judges had their work cut out for them.
The main issue that had to be decided by the courts was whether a wholly unsecured junior mortgage may be stripped off pursuant to 11 U.S.C. §506(d), notwithstanding the anti-modification protection afforded holders of home mortgages in 11 U.S.C. §1322(b)(2). [3] Section 506(a) of the Bankruptcy Code provides that "an allowed claim of a creditor secured by a lien on property in which the estate has an interest....is a secured claim to the extent of the value of such creditor's interest in the estate's interest in such property....and is an unsecured claim to the extent that the value of such creditor's interest....is less than the amount of such allowed claim." [4] Subsection (d) of Section 506 then provides that "to the extent that a lien secures a claim against the debtor that is not an allowed secured claim, such lien is void." [5]
The banks relied heavily on a Supreme Court case that held when applying the two provisions, "a lien 'strip down' of an undersecured home mortgage lien is impermissible for claims secured by principal residences, because it modifies the total package of rights which such a claim holder bargained. A lien 'strip down' reduces an undersecured lien to the value of the collateral, in contrast to a lien 'strip off', which removes a wholly unsecured junior lien" [6] The Nobleman court never addressed the issue of whether a lien 'strip off' is permissible but concluded that a lien 'strip down' is not permissible on a primary residence. It was now up to the courts to decide whether a lien 'strip off' would violate a statutory provision stating that the terms of a secured lien cannot be modified on a primary residence. The majority of courts decided in favor of homeowners and held that wholly unsecured liens may be 'stripped off'. [7]
Allowing the stripping off of wholly unsecure liens was a monumental victory for homeowners across the country. The decision became significant after the housing crisis resulted in the substantial decrease in home values across the country. Many homeowners found their homes to be worth substantially less than what is owed on the mortgages. However, the decision allowed the homeowners to strip off a second mortgage, assuming it was wholly unsecure (balance of first mortgage exceeds value of home), helping them regain value in their homes.
Lien stripping is only permissible in a Chapter 13 bankruptcy. A debtor that files a Chapter 7 may not strip off any non-judgment liens (mortgages) on their homes. A Chapter 13 bankruptcy is a repayment plan that typically lasts for three to five years, depending on the debtor's annual income. The amount repaid in a Chapter 13 depends on how much disposable income a debtor has each month and the value of the debtor's non-exempt assets. The repayment is usually anywhere between 10% to 100% of a debtor's unsecured debt.
When a mortgage lien is stripped, the nature of the debt changes from secured to unsecured. The balance is treated is an unsecured debt just like credit cards. In most cases (depending on disposable monthly income and assets), the debtor only has to repay a portion of the balance of the once secured mortgage. For example, John Debtor owns a home that is worth $200,000. He has two mortgages on the property; a first for $210,000 and a second for $80,000. He can strip the second mortgage since the balance of the first mortgage exceeds the value of the home. So, the $80,000 second mortgage changes from secured debt to unsecured debt. The significance of the transformation is unsecured debt does not have to be repaid in its entirety in a Chapter 13 bankruptcy. Assuming John has $200 of disposable monthly income, he would repay the once secured second mortgage $12,000 (60 months x $200 in disposable monthly income) over the course of a 5-year Chapter 13 plan. Once John completes the plan, the mortgage will be officially stripped from the home.
Lien-stripping can be an extremely useful strategy for homeowners that are underwater; especially since the housing crisis continues to drive home values to the ground. Lien-stripping can benefit many homeowners who have seen the value of their homes plummet in the last couple of years. Not only can a Chapter 13 bankruptcy help the debtor strip a wholly unsecure second mortgage, but also can wipe out credit card debt with minimal repayment. With no end to the recession in sight, many homeowners should consider utilizing the Bankruptcy Code as a source for financial relief.
[3] In Re Waters, 276 B.R. 879, 880 (Bankr.N.D.Ill.2002)
