Lien stripping is a way somebody in Chapter 13 bankruptcy can remove lower priority liens. It’s only allowed in cases where the value of the house is no longer enough to cover the outstanding mortgages on higher priority liens. Lien stripping turns the junior mortgage into an unsecured debt that may eventually be discharged.
Basics Of Liens
A lien is a claim to a property created by a loan such as a mortgage. It gives the lender the right to seize and sell the property if the borrower doesn’t make the loan payments. It also gives the lender a higher priority claim if the borrower goes into liquidation.
It’s possible to have multiple liens on a property, for example, when getting a second mortgage. In this case, the liens have priority in the order they were created, with later liens described as lower priority or junior.
Basics Of Chapter 13 Bankruptcy
Chapter 13 is a form of bankruptcy where the individual wants to reorganize their debts and repayment commitments rather than go into liquidation. If a court approves Chapter 13 bankruptcy, claims to seize assets (such as through a lien) are suspended for a set period.
How Does Lien Stripping Work?
Lien stripping is allowed when a homeowner is “upside-down” in their home loans, also known as being “underwater” or “in negative equity.” This means the current value of the property is less than the outstanding amounts on any mortgages.
To be more specific, lien stripping is only allowed where the current value of the property is less than the total outstanding amount on all higher priority liens.
For example, if you owe $220,000 on your original mortgage and $50,000 on your second mortgage, and your property is now worth $200,000, lien stripping is an option. In this scenario, a court can “strip” the junior lien or liens such that the lender no longer has a secured claim on the property.
Do I Still Owe The Money?
Lien stripping doesn’t immediately remove the debt. It simply converts it from a secured mortgage to an unsecured loan. You may still have to make some repayments for a set period, depending on your overall court-approved payment plan.
If you complete the Chapter 13 payment plan for the set period, your remaining unsecured debt is discharged. This means any outstanding debt on the stripped lien mortgage is written off.
What About Chapter 7 Mortgages?
Lien stripping isn’t allowed in Chapter 7, also known as liquidation. That’s because the court will seize your assets, including the property. It will sell the property and divide the money among any lien holders, in order of priority.
If you think lien stripping could be an option for your finances, you should seek expert advice. Contact Mellor today to talk through your case.