In Stripping Off Junior Liens In Chapter 7, Nothing Matters More Than Where You Live
In bankruptcy a claim is a broadly defined term meaning a right to payment. When the holder of that claim also has an interest in a specific piece of the debtor’s property to secure that this that is called a lien interest or a secured claim. All through the bankruptcy code secured claims are treated a certain way and unsecured claims are treated a different way. There is a code section, Section 506, that talks about whether claims are secured or unsecured. If the property has sufficient value to support any part of that lien then the claim is secured to the extent of that value and is unsecured if the claim exceeds that value. Take for example, a home with a fair-market value of $200,000.00 that has a mortgage of $300,000.00. That claim is secured to the extent of the $200,000.00 value and unsecured to the extent of the $100,000.00 value. Section 506(d) holds that the unsecured portion of this equation the lien is void to that extent. The bankruptcy rules allow debtors to file a motion with the bankruptcy court to determine the value of collateral that secures a claim. What does all this mean?
It means that a debtor should be able to obtain an order from the bankruptcy court establishing the value of a piece of property that is subject to a lien. Then, the debtor should be able to obtain another order of the bankruptcy court establishing that to the extent that the secued claim exceeds the property value, that excess is not secured by a lien. Armed with that order the debtor should be able to go to the land records for real property, record the order and enjoy a modified mortgage with a reduced principal balance. That’s the way it looks like it’s supposed to work. But it doesn’t work that way most of the time.
WHY IT DOESN’T WORK IN CHAPTER 7:
Mortgage stripping doesn’t work in Chapter 7 because the United States Supreme Court says it doesn’t. Chapter7 is a straight liquidation, a trustee takes title to all the debtor’s assets and liquidates them for the benefit of creditors. In the landmark case of Dewsnup v. Timm the Supreme Court ruled that a debtor could not strip off an under-secured mortgage in Chapter 7. Although the facts of that case did not address the situation where a junior mortgage is completely unsecured most courts following this case have ruled that you cannot completely strip off an unsecured junior mortgage in Chapter 7. Of course, even if Dewsnup v. Timm had gone the other way, there are conceptual problems in figuring out how you would restructure the reduced principal balance when there’s no mechanism in the Bankruptcy Code to explain how that loan would be repaid.
WHY IT DOESN’T WORK IN CHAPTER 11:
This is only partially true. In Chapter 11 and in Chapter 13 (the reorganization sections of the Bankruptcy Code) a completely unsecured junior mortgage can be stripped off as described in this video. An under-secured mortgage that is secured solely by the debtor’s personal primary residence cannot be modified because the Bankruptcy Code says so as explained in this video. Of course, if the loan is secured by other assets such as business assets or a vacation home then the under-secured mortgage can be modified in Chapter 13 or Chapter 11.
PROBLEMS WITH CHAPTER 13 MODIFICATION OF UNDER-SECURED MORTGAGES
Modifying under-secured mortgages in Chapter 13 pose a particularly difficult problem because those plans cannot by statute extend beyond 5 years after the bankruptcy is filed. Almost every bankruptcy court in the country rules that if you want to modify a loan in a Chapter 13 plan, even if permitted, you mustcomplete all payments under that modified loan within the 5-year plan. For any kind of significant home mortgage, even if undersecured paying, that typically 30-year loan off in 5 years is simply an impossible burden for most debtors to meet.